It’s the start of a new decade. I reckon it’s a good time to get rid of bad habits that might be damaging your health or your wealth. As this is an investment site, I want to focus on a problem that could be damaging your financial health. It’s called saving.
You may think you’re being a good, responsible adult by putting some of your income into a cash savings account each month. If you’re saving for a rainy day fund, holidays, or a new boiler, then I’d agree. You’re doing the right thing.
But if you’re saving cash to help fund your retirement, then I’ve got bad news. With best-buy Cash ISA rates hovering around 1.3%, you’re unlikely to hit your retirement goals. Here’s what I’d do instead.
Mission possible: £500k by 2040?
For the purposes of this article, I’m going to look at how you might build a £500,000 fund over the next 20 years. My choice would be to invest in the stock market using a Stocks and Shares ISA, or a pension. Which of these options is best for you will depend on your personal circumstances.
Pensions provide valuable tax relief that will boost your contributions today. But your money is tied up until you’re 55, and you could face future tax bills. By contrast, investing in a Stocks and Shares ISA means all future capital gains and income will be tax free. And you can withdraw your money at any time.
Option 1: buy the market
If you want to build a £500k nest egg in 20 years, how much will you need to save each month? For a stock market investment, one option would be to ‘buy the market’ by investing in a FTSE 100 tracker fund. This will invest your cash in the 100 largest listed companies in the UK, so you’ll be invested in a wide range of businesses.
Over the long term, the average annual return from the UK stock market is about 8%. Assuming this remains true, my sums show you’d need to save £850 per month for 20 years to hit your £500k goal. That’s quite a lot. Let’s see if we can find a way to reduce it.
Option 2: buy stocks
If you invest in a smaller number of individual stocks, then you may be able to outperform the market. My sums show that if you can achieve a 10% annual return, your monthly payment could be cut to £658 each month.
Beating the market isn’t easy. But if I was pursuing this strategy, I’d target a mix of value, income and growth. I’d aim to hold 10-20 stocks, split between the FTSE 100 and the FTSE 250.
In the FTSE 100, I’d mainly be looking for high-yield dividend stocks which looked unloved and cheap to me. Current examples might include British American Tobacco, cruise firm Carnival and Royal Dutch Shell.
In the FTSE 250, I’d be targeting firms with above average profitability and a decent track record of growth. For example, I might consider bus and train operator Go-Ahead Group, engineering group IMI, and financial trading firm IG Group.
These are only initial ideas — you’ll need to do a fair amount of research. But I believe this approach could work well and help you build a valuable retirement fund.
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Roland Head owns shares of Carnival, Go-Ahead Group, IG Group Holdings, and Royal Dutch Shell B. The Motley Fool UK has recommended Carnival and IMI. 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.