Saving £500,000 might feel like it’s out of reach for many of us. But I reckon I should be able to hit this target by saving as little as £5 per day, or £150 per month. In this piece I want to explain how I’d invest my cash in the stock market to build a £500k retirement fund.
How I plan to multiply my money
Although I want to build a £500k fund, I don’t intend to save £500,000 of my hard-earned cash. In fact, I only expect to have to contribute around £72,000 of my own cash to hit my goals.
The reason this is possible is because of the power of compounding. What this means is leaving any capital gains or dividend income untouched in my account and reinvesting it every year. Over time, following this approach makes a big difference to investment returns.
For example, the average long-term return from the UK stock market is about 8% per year. If I invested £1,000 at this rate and made no withdrawals, my investment would be worth £10,062 after 30 years. That’s a profit of £9,062.
However, if I withdrew the 8% return each year, my total profit would be just £2,400.
Staying with the same 8% return, my calculations show that by investing £5 per day (£150 per month) for 40 years, I should be able to build a £500,000 retirement fund.
How I’d invest the cash
There are lots of ways to invest in the stock market, but my priority is to make it simple, cheap, and reliable.
In my view, the cheapest and simplest way to invest in UK shares is to buy a FTSE 100 index fund. These low-cost funds track the progress of the FTSE 100 index, which contains the 100 largest companies on the UK stock market.
A FTSE 100 tracker fund won’t fill my life with excitement. But over long periods, history suggests that it should be reliable.
However, I can’t ignore the fact that smaller companies have earned more attractive returns over the last decade. To gain some exposure to faster-growing businesses, I’d probably put half of my cash into a FTSE 250 index fund. The FTSE 250 contains companies that are well established but a little smaller than FTSE 100 firms. Typically, FTSE 250 companies have more room left to grow.
Why I always use an ISA
I don’t mind paying tax. But the UK ISA system means that investors can invest up to £20,000 a year completely tax free. This is a no-brainer, in my view.
That’s why the first thing I did when I started investing was to open a Stocks and Shares ISA.
The £20,000 per year limit on an ISA means you can save up to £1,666 per month, tax free. That’s plenty, for most people. Indeed, my sums show that based on the 8% annual return I mentioned above, you could hit £1m in 20 years if you maxed out your ISA each month.