Over the years, planning for financial aspects of retirement has changed dramatically. You may still remember the years when it was a lot more common for people to work for an employer that would ensure that its staff had a robust retirement pension. Things have long changed. Now for the most part, the onus is on individuals to secure their retirement years.
I’ve recently had several friends ask me how they can start building a retirement nest egg if they have close to nothing saved by the age 40. Although it helps to start investing for retirement early, I believe it’s still possible to have a financially secure retirement even if you start investing later in life. Therefore, today I’ll discuss why I believe dividend stocks should be key for anyone building a retirement pot.
Dividends matter
I’d first open a Stocks and Shares ISA to start investing with all my gains free of tax liabilities. If it’s possible to initially invest a capital amount, that would of course go a long way towards building wealth.
Regardless of the amount of the initial investment, I believe everyone should put a set amount each month into a retirement account.
2020 has so far been an unnerving year to be an investor. In January and early February came new share price highs. Then we witnessed the market crash in March. But after reaching extreme oversold levels, many shares have since recovered some of their losses. Thus there’s a lot of noise in the markets, potentially causing stress and confusions for many investors.
However, if you focus on growing your dividend income rather than the short-term volatility, then it becomes relatively easier to relax as your retirement money keeps piling up. Dividends provide investors with cash flow in all market conditions. And the reinvestment of dividends can have a positive impact on total returns.
My Motley Fool colleagues regularly cover FTSE 100 and FTSE 250 shares and funds that you could consider adding to a diversified retirement portfolio. They point out that despite various downturns and even crashes, over the long run, stock markets in the UK return about 6% to 8% annually, on average.
Power of compounding
By reinvesting the proceeds, one becomes a permanent net buyer of shares. And the investor participates in the stock market’s general growth over the years and decades.
Let’s assume that you’re now 40, with £100 in savings, and that you plan to retire at age 65.
Despite the market crash, you decide to invest that £100 in a fund and make an additional £3,600 in contributions annually at the start of the year. You’ve 25 years to invest. The annual return is 6%, compounded once a year. At the end of 25 years, the total amount saved becomes £209,367.
Saving £3,600 a year would mean being able to put aside £300 a month or about £10 a day. And if you were to save £500 a month, the total amount would become £348,942.
Retiring on dividends sounds like a dream, right? As I’ve shown, seasoned investors know that with persistence and self-discipline, they can build a robust net egg and make that dream a reality.