When it comes to investing in UK indices, the FTSE 250 is often seen as not quite as good as the blue-chip FTSE 100. Yet looking at the past three decades, the former has been a far greater source of growth. For reference, the average return by the FTSE 250 is around 11% versus the FTSE 100’s 8%.
Of course, this higher return comes at the cost of greater risk, as the index contains less established enterprises. But as someone with at least a 30-year time horizon before retirement, taking on some extra volatility isn’t a dealbreaker for me.
So, with that in mind, how would I invest in the growth index when aiming for a comfortable retirement?
Retiring in style with the FTSE 250
There are several ways to start investing in an index. The easiest would be to buy an index tracker fund or exchange-traded fund (ETF). These types of investment vehicles pool together capital from thousands of different investors into a single portfolio that’s then invested in every business in an underlying index.
Using this strategy, portfolio construction, diversification, and rebalancing are all taken care of. Essentially it puts my investments on autopilot. And since these funds are typically run by trading algorithms today, the annual management fees are tiny – usually around 0.1%.
Let’s assume the index continues to deliver its average return of 11% per year moving forward. If I invest £500 monthly from my salary for 30 years, my portfolio would hit a lovely total of £1.4m. Following the 4% withdrawal rule, that’s the equivalent of just over a £56,000 retirement income – not including the extra from the State Pension.
As delightful as that sounds, there are some caveats. Over the next 30 years, the stock market will undoubtedly suffer through potentially multiple corrections or crashes. When those will occur is anyone’s best guess. But depending on the timing, it could significantly disrupt the wealth-building process. In other words, my nest egg could be worth considerably less.
So, what can I do as an investor to bypass this problem?
Taking on risk to achieve higher returns
Even if the FTSE 250 lives up to expectations, there’s still a fundamental restriction in taking this investment approach. It’s impossible to outperform the stock market.
That’s where stock picking has the advantage. By only choosing the 25 companies in the FTSE 250 that I believe to be the best, I could unlock the potential to outperform the index without compromising diversification.
Of course, there’s no guarantee that this will yield higher returns in practice. In the last couple of years, we’ve seen how disruptive external forces can be on industry leaders. And it’s possible that the best businesses today won’t necessarily stay that way in the long run.
That’s why individual stock picking requires a more hands-on approach. I’ll have to keep an eye on my positions and perform any necessary portfolio rebalancing. It’s a lot more work that requires time, dedication, and most importantly, emotional discipline to pull off. That’s why it’s not suitable for everyone.
But since it opens the door to higher returns, the risks of this alternative investment strategy are well worth the long-term rewards for me. At least, that’s what I think.
The post I’d put £500 a month into the FTSE 250 to aim to retire in comfort appeared first on The Motley Fool UK.
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