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.
Start saving
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.