How I’m using £20 a day to try to retire early, and in comfort!

Entrepreneur on the phone.

My strategy for retiring early is based around the miracle of compound returns. This is the practice of investing in dividend stocks and earning interest on my interest. The longer I leave it, the more money I have, as returns grow exponentially over time.

So let’s take a closer look at how compound returns works, and my top stocks for the strategy.

Compounding returns

Compounding returns is a strategy that requires me to reinvest my dividends. In order words, I need to be in a position whereby I don’t need the dividend payments now.

So let’s say I invest a slump sum of capital, £20,000, into four income stocks offering me a 5% yield on average every year.

And at the end of the first year I reinvest the £1,000 I receive in dividends. So I’ll have £21,000 (assuming the share prices remain constant).

So at the end of 30 years, I’d have £50,000 right? Well, if I did think that, I’d be wrong. That’s not how compounding works. Instead, I’d actually have £89,000! Because I’d be earning interest on my interest.

But the impact of compounding is even greater if I contribute regularly. In fact, contributing regularly is core to my investment strategy.

So if I invested just £20 a day, or £600 a month on top of the above, after 30 years I’d have £588,000.

Now that’s a big chunk of money. And this would certainly help me retire early. With that, I could generate nearly £30,000 in passive income each year if I kept my money in dividend stocks paying 5% annually.

It’s also worth remembering that share prices tend to move upwards. For example, the FTSE 100 started nearly 40 years ago, but today, the value of the UK’s top 100 companies is 7.5 times greater than it was back then. This is indicated by the fact that the FTSE 100 index is currently around 7,500, and the index started at 1,000.

If I choose well, I’d expect to see the value of the share I own increase over the next 30 years too. But I have to accept that some of my picks could go down too!

Where to put my money?

I’m investing for the long run, so I want to be sensible. Obviously I can move my money between different stocks over time, but I want to start off with sensible choices.

Ultra-high dividends might be attractive but, in reality, it’s normally unsustainable. I’m looking at firms that can offer me something around 5%, and do it sustainably.

Lloyds is a top choice for me right now. The bank, which is heavily focused on the comparatively low-risk mortgage market, currently has a 4.5% dividend yield. And with net interest margins on the rise, I wouldn’t be surprised to see that move up further in the coming months or years if higher interest rates are sustained.

Another option is life insurance specialist Phoenix Group. It’s currently offering a dividend yield of 7.5%. I see this blue-chip insurer as a good long-term bet for my portfolio. It buys out and manages legacy life insurance and pension funds that are closed to new business and manages them. Phoenix has a track record of clever acquisitions and mergers to continue growing the business.

The post How I’m using £20 a day to try to retire early, and in comfort! appeared first on The Motley Fool UK.

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James Fox owns shares in Lloyds Bank. The Motley Fool UK has recommended Lloyds Banking Group. 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.