Saving for retirement is undoubtedly a sensible decision, but compared to investing in cheap UK shares, it’s hardly the most effective method of building a large nest egg. Even with the latest increases in interest rates, the passive income offered by savings accounts is still negligible.
Fortunately, investing in the British stock market is a proven method of building meaningful wealth over the long term. And thanks to all the volatility this year, plenty of high-quality companies are trading at cheap valuations.
So, how can I find these top-tier investment opportunities? And what level of return should I expect?
Finding the best cheap UK shares to buy today
In the short term, stock prices are driven by mood and momentum. But in the long run, the underlying business defines whether shares move up or down. If the company performs well, profits increase, and shares become more valuable. Of course, the opposite is also true.
So, to succeed as a long-term investor, it’s not about finding which stocks are likely to surge the fastest. Instead, the question I should be asking is which business is going to grow the most in the next 10+ years.
Predicting a decade into the future is obviously easier said than done. But there are some tell-tale signs that can indicate a potentially winning investment.
The first thing I like to check is the balance sheet. Here I can find a detailed breakdown of a firm’s liquidity and the amount of debt it has to service. Seeing a high degree of financial leverage can be cause for concern. After all, how can a business thrive in the future if it can’t stay financially healthy?
But debt can be a powerful tool when used correctly. That’s why I believe it’s critical to also look at cash flows. A high debt balance isn’t necessarily a problem if enough capital is generated to cover the interest expenses. Substantial cash flows also provide a buffer for any dividends that may be getting paid, protecting the source of passive income.
There’s obviously more to analysing a business than just these factors. But in my experience, this is enough to eliminate many poor-quality UK shares.
High returns aren’t risk-free
Here in the UK, the FTSE 100 generates an average annual return of 8%, including dividends. But through individual stock picking, hitting a 10% or even 12% return is entirely plausible, providing I invest in high-quality businesses.
That may not seem like much, but it’s substantially more than any savings account will offer. In fact, putting aside just £300 a month into the stock market at a 12% return for 30 years will build a portfolio worth just over £1m. Not bad, if I say so myself.
But unlike putting money in a savings account, investing, even in cheap UK shares, is far from risk-free. The stock market can be volatile, as many investors have discovered in 2022. And it’s entirely possible for my portfolio to move in the wrong direction.
Some of this risk can be mitigated through diversification. But not all of it. And investors need to be prepared for the worse. Having said that, given the potential rewards, investing is still a far better retirement strategy than putting money into a savings account. At least, that’s what I think.