A lot of people like the idea of bringing forward their retirement. But to do that, it helps if one can save enough money to cut short one’s working life. One way I am trying to do that is by investing in shares that hopefully will pay me dividends. Here are three steps I would take to try and retire early by investing in income shares.
1. Start right now
Time is of the essence when it comes to investing. The longer I own shares, the more time I have for any dividends to pile up. The difference can be significant.
As an example, imagine that a 30-year-old invests £10,000 today into Legal & General shares, at the current dividend yield of 7.2%. She does not invest any more into the shares but compounds the dividends annually. At the age of 65, she would own £114,000 worth of Legal & General shares. Her friend follows exactly the same approach, but is 40 not 30. When he hits 65, the Legal & General shares he owns will have a value of £57,000.
In other words, although he invests the same amount of money and holds the shares for a quarter of a century, at 65 he still ends up with only half as much money as his friend.
That shows how starting investing for retirement early can make a big difference to returns, and help to bring forward a retirement date. But how early is early? After all, many people plan to start investing in income shares once they are just a bit older, or have more spare money.
My approach is: why wait, even for a day? The sooner I begin, the earlier I could hopefully retire.
2. Compound dividends
The example above includes a few assumptions. For example, I assume that Legal & General’s share price and dividend will be constant. In practice, they could go up or down. But the principle is clear: starting early gives a longer timeline for wealth to accrue, which can fund an early retirement.
But why do I presume in the above example that I would compound my dividends? It is because compounding is like pushing a snowball downhill. The dividends themselves can be reinvested in more shares and generate extra dividends, which in turn can do the same thing. That is why compounding is so powerful: it can mean I have more money to invest than I actually put into my retirement account.
3. Buy a range of income shares
One of the shares in my pension plan is fund manager Jupiter. It has a dividend yield of 16.7%. Compounding that over decades could help me retire early!
But can it last? Such a high dividend yield is often a sign that the City expects a company to cut its dividend. That might not happen, but it is always a possibility. If I sunk all my pension into Jupiter – or any other income share – only for it to cut its dividend, my retirement planning could be thrown into disarray.
That is why, as well as hunting for quality at an attractive price, I always make sure I diversity my retirement funds across a range of shares.