A lot of people buy shares for a very specific reason. They want to invest for retirement. The hope is that, over the course of decades, the value of a portfolio will grow and, in retirement, dividends can provide regular income.
To try and achieve that goal, I would use three straightforward but powerful investing principles.
Benefit from compounding
Dividends could certainly be a useful source of regular income when I retire. But if I earn them now, should I spend them, or simply reinvest them in my retirement portfolio?
The difference in long-term wealth creation can be dramatic. Imagine that I invest for retirement by setting up a share portfolio worth £100,000 today that generates an average dividend yield of 5%. If I did not invest any more money for 20 years and spent the annual dividends of £5,000, I would end up two decades from now with a £100,000 portfolio, if share prices were flat.
But what if I reinvested the dividends and otherwise did exactly the same? In 20 years, my portfolio would be worth £271,000. That in itself would be generating over £1,000 in monthly dividends.
That is because of the miracle of compounding. Compounding dividends while I work is a powerful way to increase my monthly income when I retire.
Focus on great quality companies
In the example above, I used a 5% average dividend yield. I think that is achievable while investing in blue-chip FTSE 100 companies right now.
The example would be even more dramatic with higher yielding shares. But a key principle I adopt when I invest for retirement (or indeed any purpose) is never to chase high yields unless it is accompanied by high quality. In other words, I focus first on finding businesses I think have solid long-term business prospects. Only then do I start to look at their share price and dividend yield.
Retirement planning is a long-term activity. Just because a share pays a high dividend now does not mean it will do so decades from now, or even next year. So I hunt for companies with business models I reckon can benefit from resilient demand that also have strong competitive advantages.
Never too early to invest for retirement
If I did find such companies I might be able to make the £100,000 in my example above work harder to fund my retirement. I think making my money work harder for me is more attractive than me having to work harder for money before I retire!
For example, if I invested an average dividend yield of 6.6% on my £100,000 for the same period of 20 years, I would then be able to have a dividend income slightly above £2,000 a month. Shares such as Legal & General currently trade with a yield over 6.6% and I could build a diversified portfolio of them.
But even with a lower yield, or indeed less money to begin with, I could hopefully still get to my £2,000 target of monthly retirement income if I had a long enough timeframe. The more years I have before retirement, the more powerful the effect of compounding, no matter how much I am investing.
It may still seem a lifetime away, but I think it is never too early to invest for retirement.
The post How I’d invest for retirement income of £2,000 each month appeared first on The Motley Fool UK.
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C Ruane has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.