Retiring early seems to be a goal that’s becoming more distant for many people. A higher cost of living, an inadequate State Pension, and low savings account interest income means it can be difficult to enjoy financial freedom in older age.
However, investors such as Warren Buffett have shown the stock market can provide a simple means of building a retirement nest egg. Through buying and holding undervalued companies that offer long-term growth potential, it may be possible to obtain a high annualised return that produces a surprisingly large retirement nest egg. It may even allow you to retire earlier than expected.
Buying and holding
For many people, investing in the stock market conjures up images of rapidly buying and selling stocks with the aim of making a quick profit. While this may be the case for some investors, Buffett and other long-term investors adopt a buy-and-hold strategy. This entails them buying a stock and allowing it a period of many years, or even decades, to produce a high return.
The advantages of a buy-and-hold strategy include lower commission costs and less effort on the part of the investor. Additionally, buying and holding stocks can be more profitable than looking to make a quick buck. It provides the companies held in a portfolio with the time they need to benefit from the cyclicality of the stock market. It also means there’s sufficient time for them to put into effect the strategies they have to deliver improved financial performance.
Quality businesses
Of course, a key part of generating high returns is buying the best companies available. Identifying these can be a difficult process, and it may take time to unearth the most attractive stocks in a specific sector.
However, starting with a few simple rules can make a significant difference to your returns. For example, avoiding companies that have high levels of debt can lead to less risk. Likewise, stocks that have strong cash flow, or an economic moat, may be better able to overcome challenging operating conditions to post improving financial performance.
Through identifying the best companies that can grow their bottom lines at a fast pace, you may increase the chances of generating high returns in the long run. Certainly, the financial forecasts for companies may not become a reality. But, in many cases, businesses with a competitive advantage over their peers may be able to grow at a faster pace.
Valuations
With the FTSE 100 having recorded a decade-long bull market, investors may think there are a lack of undervalued stocks at present. However, a number of large-cap shares have ratings below their historic averages, which means they may offer a wide margin of safety.
Through buying stocks when they trade at a low ebb, it may be possible to favourably position your portfolio ahead of a period of future growth. This could catalyse your portfolio and improve your chances of enjoying financial freedom in older age.