You may be tentatively contemplating retirement or ready to embrace it with open arms. Whichever it is, you’ll enjoy retirement a lot more with money in your pocket.
State Pension woes
The retirement age to qualify for the State Pension has been creeping up in recent years. It’s now age 67 and many people predict it won’t be long until it’s 70. The State Pension is £168.60 per week, equivalent to £8,750 a year, which is unlikely to allow many working people to maintain their lifestyle in retirement. So, if you’re one of those hard-working individuals seeking a way to retire early using self-generated income, then who can blame you?
Long relaxing days spent with those you love is the dream of retirement for many. One reason people aim for early retirement is to get the most out of life while relatively young and fit. Another is getting away from working in a stressful and often thankless environment.
But you need money to do it. Money should not be the be-all and end-all of retirement, but it helps. Can you keep up your lifestyle in retirement? Consider the implications of having to work longer if you’re unwell, followed by having to survive on the meagre State Pension.
But how can you increase your pension pot? I would always advise investing in FTSE 100 companies or buying into a fund that tracks the FTSE 100 index in order to generate the extra cash you need. And I’d do so through a Stocks and Shares ISA.
The power of dividends
The FTSE 100 index contains the top 100 companies listed on the London Stock Exchange, according to their market capitalisation. This includes big names such as BT, Shell, HSBC and Imperial Brands.
These are hugely valuable businesses (you can calculate a company’s market cap by multiplying the number of outstanding shares the company has traded in the market by its stock price). If a company has reached FTSE 100 status, then it stands to reason that it’s got staying power. Although there will always be a few bad apples, most FTSE 100 companies can be relied upon to pay dividends and to pay them consistently. Some 97% of the FTSE 100 constituent companies offer a dividend to their shareholders and that’s why investors love these shares.
Around 5% is considered a good and relatively safe dividend yield, but dividend yields vary. JD Sports‘ yield is a mere 0.2%, while at Evraz it’s over 14%. If it’s too low, it’s less attractive of course, although a very high dividend yield can be a warning sign that the company has issues.
Let’s say you have decided to stick to shares with yields in the mid-range. What’s important next is dividend reinvesting. This is the key to unlocking the power of compounding. Reinvest your annual dividend payment in new shares and the next year that 5% yield is paid on a larger sum, and the next year too. These small additional bonus payments that your capital receives routinely can add up to a much bigger pot over time.
Compound dividend investing is a tried and tested way to build a nest egg for early retirement and the earlier you start, the better.
Kirsteen has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.