No savings at 40? I’d use the Terry Smith method to get rich and retire early

Terry Smith could have retired years ago if he’d wanted to. As one of the UK’s most successful fund managers, however, his investors will be glad he didn’t. In just 10 years, Smith has grown his Fundsmith Equity Fund into a £21bn behemoth. 

I think everyone could benefit from listening to the main man. In fact, I’m a firm believer that anyone beginning their investing journey in their 40s could still retire early by adopting his methods. 

Terry Smith buys quality

Smith is a quality investor and focused on buying great companies. But what makes a company great?

You might think it’s all about rising profits. Smith, however, prefers to focus on a company’s Return on Capital Employed (ROCE). This is what it makes from the profits put back into the business to help it grow. The higher the percentage, the better. The average ROCE across Fundsmith’s portfolio is around 29% compared to the FTSE 100’s 16% or so.

Of course, Smith wants more than just a high ROCE. The cycling enthusiast seeks out companies that have “already won” and occupy a dominant position in their markets. 

He also looks beyond the London Market. As tempting as it is to ‘back what you know’, I think new investors should do the same. In addition to providing some protection from things like Brexit, opening your portfolio to high-growth overseas stocks can generate a far better return, as Fundsmith has shown.

Avoid high-income stocks

Terry Smith isn’t an advocate of income investing. Instead of distributing profits out to owners, he’s looking for companies that have a better use for the cash. 

This is an important point to grasp if, like me, you’re in your 40s. With many years left in my stock market journey, I’m reinvesting whatever I receive back into the market without exception.

Not spending what I receive ensures I’m taking advantage of compound interest as much as I possibly can.

Don’t obsess over prices

Most investors pay too much attention to valuations, according to Smith. The price you pay is important, of course, but it’s what the business does over time that really matters.

In a brilliant presentation, Fundsmith’s CEO explained how anyone paying as much as 32 times earnings for US drinks giant Pepsico and holding for years would still have beaten the return from the S&P 500 index.  

As a 40-something new investor, it might be tempting to buy nothing but screamingly cheap stocks in an effort to ‘catch up’. Some may even be tempted to throw everything they have at massively-hyped penny shares. Terry Smith’s performance over the years shows this level of risk-taking isn’t required.

Ignore the noise

Sure, Smith is successful because he’s a great stock-picker. However, he’s also successful because he cares little for what the global economy is doing at any particular time. This aversion to market timing means Fundsmith has incredibly low portfolio turnover. By minimising transaction costs, Smith therefore retains more of his profits. 

As someone in my 40s, I try to adopt a similar approach. Even when I do purchase shares, I normally take advantage of my broker’s regular investment plans. Buying on a fixed day in the month can actually reduce commission costs to zero! 

Save money where you can and retiring early need not be a pipe dream.