Saving money for retirement may not be the best means of making a passive income in older age. Low interest rates mean that obtaining a high annual return that builds a nest egg over time is a very challenging task.
As such, investing money in UK shares while they trade at cheap prices could be a more profitable move. In many cases, high-quality companies can deliver rising valuations over the long run as the economic outlook improves. This may lead to a larger income in retirement.
Cheap UK shares can help build a passive income
The track record of the stock market shows that UK shares have been a sound means of obtaining a generous passive income in retirement. For example, the FTSE 250 traded at around 6,700 points 20 years ago. Today, its price is around three times that level despite experiencing numerous crashes, downturns and challenges along the way.
As such, when reinvested dividends are included, a £10,000 investment in mid-cap shares 20 years ago would be worth around £52,000 today.
An investor who buys UK stocks today could realistically obtain an even higher return than that of the stock market. Due to the 2020 market crash, many FTSE 250 (and FTSE 100) shares are trading at prices that may undervalue their long-term prospects.
For example, they may face a period of lower demand for their products. Or they could be forced to adapt to changing consumer tastes. However, their financial strength and capacity to adjust over the long run may mean they produce impressive returns, as well as a growing passive income, relative to the wider stock market.
Investing money in shares right now versus holding cash
Buying cheap UK shares has been a successful strategy to obtain a large passive income in the past. Investors who purchased shares following events such as the 1987 crash, the dot com bubble and the global financial crisis are likely to have benefited from the stock market’s recovery.
Since the UK stock market continues to trade at a discount to its all-time high, there may be scope to do likewise at the present time.
Of course, holding some cash is always a good idea for all investors. It provides peace of mind during what may prove to be an uncertain period for many people. However, relying on it to build a retirement income is unlikely to be an effective strategy.
Certainly, in the past, cash savings accounts were able to offer positive returns on an after-inflation basis to produce a passive income in older age. However, with UK interest rates now almost at zero, the prospects of earning a generous income in retirement via cash savings accounts seem limited.
Therefore, capitalising on low valuations across UK shares seems to be a better means of planning for retirement.