No savings? Consider building a powerful income with dividend stocks
It’s never too late to target a large retirement income with dividend stocks.
Thanks to the wealth-building power of the stock market, even middle-aged investors with nothing at all in savings or investments can create a portfolio large enough to deliver a healthy passive income in later life.
Want to see how?
Beating the taxman
A key plank to building wealth is to reduce tax-related expenses as much as possible. For people starting later on and with zero in the bank, tax efficiency becomes even more important.
In the UK, tax is paid on capital gains above £3,000 at a rate of 18% to 24%, depending on one’s personal tax bracket. This can take an enormous bite out of one’s returns, and impact your ability to grow wealth through compounding.
To add insult to injury, dividend tax rates were hiked during the recent Budget, and will be 10.75% to 39.35% from next year. Dividend income above £500 is subject to this crushing levy.
Eliminating these tax expenses is therefore critical, and can be achieved with both the Stocks and Shares ISA and Self-Invested Personal Pension (SIPP).
With an ISA, no income tax is charged on withdrawals, either, leaving investors with more in their pocket.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
A £39k dividend income
Another important wealth-building trick is to stay patient and avoid rash decisions.
It sounds simple, but many investors panic when reviewing their pension pots and rush into high-risk assets, derailing their retirement plans.
The most successful investors use time as a tool to build their wealth. They put faith in the historical returns of the stock market, and hold onto the shares they buy for the long haul.
Stock investing delivers an average annual return of roughly 9% over time. That means even starting later in life, steady contributions can grow into a substantial nest egg.
Taking into account those returns, someone aged 45 with £0 in savings and investing £500 a month could build a portfolio of £560,560 by the time they reach 70.
If that portfolio were then invested in dividend stocks yielding 7%, our investor could enjoy a passive income of £39,239 per year. That’d be enough to make a real difference in retirement.
Building a portfolio
That said, past performance isn’t a guarantee of future returns. And investing in shares is still riskier than, say, locking one’s money up in a low-yielding cash account.
However, investors can reduce risk and effectively target a large and stable return with a diversified portfolio. Exchange-traded funds (ETFs) like the iShares S&P 500 (LSE:CSPX) are simple, cost-effective ways to achieve this.
By investing in hundreds of blue-chip US shares, this fund eliminates overdependence on particular sectors. It’s a strategy that not only reduces risk, it also unlocks a world of different investment opportunities. These range from high-growth tech shares (like Nvidia) and banks (JP Morgan), to rock-solid utilities (American Electric Power) and food producers (Kraft Heinz).
Being a stocks-based fund, it can fall sharply during broader market downturns. But over the long term it has the potential to deliver knockout returns. Annual returns have averaged 14.3% since late 2015.
As you can see, targeting a large retirement income with dividend stocks is perfectly achievable — if you follow the right plan.
The post No savings? Consider building a powerful income with dividend stocks appeared first on The Motley Fool UK.
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JPMorgan Chase is an advertising partner of Motley Fool Money. Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has recommended Nvidia. 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.
