In case you didn’t know, the State Pension isn’t a gateway to riches. Those who retired after April 2016 get just £168.60 a week, or £8,767.20 a year. That is roughly a third of the average UK income, and nowhere near enough for you to retire comfortably.
If you’re lucky, you’ll have a company pension. But even if you do, you should also look to save tax efficiently in a Stocks and Shares ISA to build extra funds to your name.
Some people are deterred from investing because they don’t believe they’ve enough spare money. However, even a modest amount can grow over time, especially if you start when young. By investing just £3 a day, you could generate income of around £9,000 a year in retirement, more than doubling your income from the State Pension alone. Financial freedom could be yours – and for less than you think.
Since inception, the FTSE 100 index of blue-chip stocks has returned on average 9% a year. Even if it doesn’t match that performance in future and grows at 7% a year, it can still help your money compound over the years.
Say you invest £1,000 today. If it grew 7% a year, you’d have £14,975 after 40 years. If it grew at 9% a year, you’d have almost £31,409.
This is why it’s so important to invest in shares rather than cash over the longer run. With savings interest of just 1.4% a year, the best rate on instant access today, your £1,000 would grow into just £1,744.
Little goes a long way
So what if you invest just £3 a day? That works out as £1,095 a year. After 40 years, your money will be worth £233,902, assuming 7% growth. That’s a tidy nest egg, but how much income would it generate in retirement?
Something called the 4% rule can help you calculate that. This states if you draw 4% of your pension pot each year and leave the rest invested, your money should never run out. This is known as the safe withdrawal rate.
If you withdrew 4% of £233,902, you’d have income of £9,356.08 a year. That’s higher than today’s State Pension, so you’ll be more than doubling your income.
More growth = happier retirement
If your annual total return from capital growth and reinvested dividends income is higher at 9%, averaged over 40 years, you’ll have £403,280. Taking 4% of that would give you income of £16,131, on top of your State Pension. You could also generate even more growth by investing in individual FTSE 100 stocks.
So by saving just £3 a day, you can achieve financial independence from a passive income after you stop working.
If you don’t have 40 years, you’ll have to invest more. So if you have 30 years to retirement, you’ll have to invest around £6.30 a day. That would give you £232,468, assuming 7% growth. If you have 20 years, you must up that to a more daunting £14.80 a day to build a similar sum.
So don’t hang around. The earlier you start, the greater your chances of achieving financial freedom in retirement.
Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.