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Is there a good way to invest income to avoid relying on the State Pension?

To the question: yes, I believe there is. No matter what stage of life you’re at, or what your income is, it’s distinctly possible that you’ll want to boost your savings so that you don’t have to rely on the fairly measly State Pension.

Investing any income you get from a job, downsizing property, selling or running a business, or whatever it may be, is a sensible move. I believe the best way to go about maximising the value of your income is to invest it in a broad range of shares and investments that pay dividends so that in the end you can earn interest on top of interest – a phenomenon I’m rather keen on, called compound investing.

The joy of compound investing

The Motley Fool has covered the wonder of compound investing in detail. If you want to learn even more about it you can, but for now, it’s worth realising that what it boils down to is growing your wealth year on year.

For example, say you own a portfolio of shares worth £1,000. If the average dividend yield is 5%, then you get £50 paid to you in dividends. If you buy more shares with that income, you have a portfolio worth £1,050, assuming that share prices don’t rise or fall. Now, the next year’s 5% will pay you an income of £52.50 and so on and so on.

Over time, these small increases really start to multiply and can create substantial incomes. This is compound investing in action. 

Finding dividend-paying investments

To benefit from compounding when investing, it’s essential to focus on investments that pay a dividend. There’s always a temptation when investing to focus on risky, potentially high-growth stocks, but I think this is the wrong approach if you want to maximise the potential of your current income to fund a better retirement. 

The good news is that a majority of FTSE 100 companies pay some sort of dividend, ranging from the likely unsustainable 9% and 10% yields on offer down to very small 1% or 2% yields. The safest course of action may be to pick shares that offer a sustainable yield and that are at neither extreme. A 3% or 4% yield, compounding over many years, will become a considerably larger sum.

If you’re not a fan of picking your own shares, there are many investment funds and investment trusts, run by professional managers, that also pay dividends either quarterly, bi-annually, or annually.

Avoiding relying on the State Pension

Many people have the capability to put aside at least a bit of their income each month to help grow their savings and avoid relying on the State Pension in old age. It’s definitely worth doing because combining the benefits of compound growth and share price rises over a long timeframe can work miracles for building up wealth.

The key I believe is to pick dividend-paying investments and hold them for a long time. That’s a good way to use income to avoid relying on the State Pension.

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Andy Ross 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.