The State Pension may benefit from a triple lock over the coming years, but its current level of £8,767 per annum is unlikely to be enough to offer financial freedom in older age.
As such, the vast majority of people will need to build a retirement nest egg that offers a passive income in older age. Here’s how I’d approach that task, and why investing in the stock market could make it easier.
Risk/reward
Investing in any asset involves a trade-off between risk and reward. For example, holding cash or buying a government bond is a low-risk investment that’s highly unlikely to lose money for an investor. However, the returns on offer at present from both assets are exceptionally low.
By contrast, the stock market offers the potential to earn a much higher return over the long run. But it comes with a risk of loss which could lead to challenging periods for an investor.
As a result, planning for retirement involves determining the level of risk that an investor is comfortable taking. The more risk that is taken, the higher the potential rewards. As such, for someone who has a long time until they plan to retire, they may have the capacity to take relatively high risks with their capital to generate more attractive returns.
The end result could be short-term volatility that includes paper losses. However, the size of your retirement nest egg could end up larger from investing in shares compared to holding cash or bonds by the time retirement comes along.
Diversification
Investing in the stock market may be risky, but the chances of losing money can be reduced through holding a diverse range of shares. Investors may wish to hold multiple companies in their portfolio that operate in different industries and geographies. This may mean their capital is less exposed to local risks, as well as the potential for one company’s poor financial performance to impact on the outcome for the wider portfolio.
Diversification is necessary for all investors since it’s all too easy to make mistakes when buying stocks. After all, the future is a known unknown. Fortunately, diversifying is cheaper than ever, with low-cost online sharedealing and tracker funds making it a relatively simple and efficient process for a range of investors.
Undervalued shares
While there are a range of investment strategies used to build a retirement nest egg that provides a passive income, value investing could be a relatively reliable approach. It’s simple and straightforward, since it involves identifying the best businesses that are available at the lowest prices.
Clearly, the quality of a company is highly subjective, as is its valuation. However, by adopting a consistent approach that enables you to find the most attractive investment opportunities within a specific industry, you may be able to improve your returns and generate a larger nest egg from which to make a passive income in older age.