For most Britons, the idea of retiring with a personal investment portfolio worth £1m might seem like an unrealisable dream, but I believe it is actually quite possible. The key is to own robust dividend shares and use the distributions to buy more stocks.
This strategy kicks off a powerful compounding process that can turn relatively modest initial investments into a significant retirement fund. Let’s see how.
Why I’d buy dividend stocks regularly
Research shows that investors who purchase dividend-growth stocks and reinvest the dividends to buy more shares are likely to see considerable growth in their savings.
The City tends to regard companies that pay dividends as more stable than those that do not. Over the long term, their share prices tend to be less choppy too.
And seasoned investors realise that the recent market sell-off provides an attractive opportunity for buying dividend shares, especially in retirement portfolios.
On 7 May, the Bank of England (BoE) decided to keep the main interest rate unchanged at 0.1%. The BoE website details the progressive decline of interest rates over several decades. As you can see, 0.1% is a record low.
My Motley Fool colleagues regularly cover FTSE shares and funds that you could consider adding to a diversified retirement portfolio. They point out that the despite various downturns and even crashes, over the long run, stock markets in the UK return about 6% to 8% annually, on average.
It all adds up
Let’s assume that you are now 25 years old with £5,000 in savings and that you plan to retire at age 65.
You decide to invest that £5,000 in a fund now and make an additional £6,000 of contributions annually at the start of the year. You have 40 years to invest. The annual return is 6%, compounded once a year. At the end of 40 years, the total amount saved becomes £1,035,715.
Saving £4,000 a year would mean being able to put aside around £500 a month or about £16 a day. It may be time to avoid that impulse purchase.
Making the right investment decisions in stock markets is not necessarily about constantly picking winning shares and funds. Rather it’s about having a long-term strategy.
FTSE stocks
Until the recent market uncertainty, many FTSE 100 and FTSE 250 shares paid juicy and stable dividends. Over the years, they have helped buy-and-hold investors become quite wealthy. However, in recent weeks scores of company boards have felt the need to suspend dividends in order to preserve cash for the rest of the year.
Nonetheless, there are still many robust businesses that are continuing to pay dividends. If you’re looking to add new holdings to your portfolio, I’d start my research with their stocks.
In the FTSE 100, I believe AstraZeneca, BAE Systems, GlaxoSmithKline, National Grid, Pennon Group, Tesco and Unilever could be solid picks for a personal pension portfolio.
If the FTSE 250 is on your radar screen, then you may want to take a look at the fundamentals for Avast, Britvic, Centamin, Moneysupermarket, and Tate & Lyle as potential long-term investments.
A diversified portfolio is always recommended. After all there is no guarantee that any one stock will generate high returns in the future.
However, the strategy of owning top dividend stocks is a proven one. And the London Stock Exchange (LSE) is home to many companies than have made long-term investors wealthy.
