A cool quarter of a million pounds is quite a nest egg. While it may sound like the stuff of dreams, I think breaking a target down into a series of discrete steps can make it easier to achieve. Here is how I would aim to do that by investing a spare £500 each month in cheap UK shares.
Why I’d buy shares
There are a couple of ways in which buying shares could help me reach my target. One is capital growth – any increase in the value of cheap UK shares I buy during the time I own them. For example, if I buy shares I see as undervalued at £1 each and years later sell them for £3 apiece, I will have tripled my investment.
The second helpful contributor to my goal could come from dividends. Those are payments a company makes to its shareholders. If I invested £1,000 in shares today with what is known as a 5% dividend yield and the company maintained its dividend, I should receive £50 in dividends year after year as long as I owned the shares.
Aiming for the target
If I was able to use a growing cash pile to achieve capital growth and dividend income, that could help me achieve my goal. In fact, I could reinvest the dividends – something known as compounding. That could mean I was investing more than £500 per month without having to raise my monthly contribution.
But there are a couple of caveats. Share prices can go down as well as up, so capital growth is not guaranteed. Similarly, dividends are never a given. Even a highly profitable company that has paid big dividends regularly can change its priorities and decide to stop paying profits to shareholders.
Risk and reward
So what should I do? My approach would be to try and make the plan work for me, while trying to limit the downside risk. To do that, I would only invest in companies I felt I really understood. Companies publish their annual report and accounts, so I should be able to learn a lot about firms just by reading those documents.
I would then look for specific factors I felt could help a company grow profits in future, such as a strong position in a growing market, or a unique technology that meets a key customer demand.
I would also rule out companies if they had risks I did not like. For example, a balance sheet burdened with too much debt could make me decide not to buy shares, even if the business had attractive features.
Can cheap UK shares add up to £250,000?
Imagine that the value of my portfolio compounds by 12% each year. That could be from capital growth, dividends, or a combination of both. If I continue investing £500 a month, I should have built my portfolio value to £250,000 in under 16 years.
Compound annual growth of 12% is more challenging to achieve year after year than it may sound though. Shares like Persimmon currently yield over 12%, but if the economy worsens, dividends could fall. A recession could also hit growth prospects at some companies.
So although I do think I could possibly hit my target, I will need to choose shares carefully when investing my money!