With the full rate of the new State Pension currently at £175.20 a week, I reckon it’s a good idea for me to build a fund capable of providing a second income in retirement. I’d find it difficult to live on what works out at just over £9,110 a year without living a spartan lifestyle. And spartan isn’t what I had in mind for my autumn and twilight years. So, I’d aim to invest £100 a month to fix the problem.
How I’d invest £100 a month
I’d invest the money in a Stocks and Shares ISA to build a fund for my second income. And I’d choose to invest in shares and share-backed funds. This is because equities have historically outperformed all other major class of asset, such as cash savings and bonds.
Over the long term, many sources quote the historical annualised returns from stocks in general as a high single-digit percentage. And that figure would include income received from dividends and capital appreciation from rising share prices.
To be conservative, I’d assume a base annualised return of 7%. And it’s surprising how my investment fund could grow over time. Key to the process of building wealth is for me to compound my returns by remaining invested. And by ploughing dividends and capital returns back into my investments.
I ran the figures through an online compound interest calculator. And investing £100 a month and compounding an annualised gain of 7% would give me a pot of money worth around £264k after 40 years. That strikes me as a decent outcome for a relatively modest monthly investment.
Harvesting yield from my investment pot
And with £264k, I’d have plenty of options for generating a healthy second income. For example, I could put the entire sum in an FTSE 100 tracker fund and collect the dividend yield. Historically, the FTSE 100 has yielded in excess of 4%.
But even assuming a modest 4% yield, it would generate a second annual income worth £10,560. And that beats the State Pension. But, of course, I’d have both!
I’d aim to increase my monthly investments as the years go by to keep up with inflation and my hopefully-rising income. So, the final pot of money should be able to keep up with the State Pension as it rises in the future.
But I’d also aim to achieve returns greater than an annualised figure of 7%. Indeed, the key variables affecting the process of compounding are the length of time and the rate of return. So, I’d start as soon as possible. And I’d choose my investments carefully.
Within my Stocks and Shares ISA, I’d direct those monthly contributions into low-cost funds to begin with. For example, I’d likely begin my investing journey by spreading the money between maybe three index tracker funds following different markets. But I’d also look at investment trusts and the shares of exceptional companies.