Contributing to a SIPP (Self-Invested Personal Pension) is a great way to build wealth for retirement. With these pension accounts, one typically gets access to lots of different growth assets (stocks, funds, ETFs, etc), tax-free investing, and tax relief.
The key, however, is to start contributing early. If someone starts contributing before 45, the results can be quite remarkable.
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.
Starting early can lead to huge retirement savings
Let’s say that you were able to achieve a return of 8% per year from a SIPP over the long run. And let’s also say that you were contributing £800 per month as a basic-rate taxpayer (the government would add in another £200 per month for you taking the total monthly contribution to £1,000).
If you were to start contributing at 50, you’d have approximately £330,000 by the age of 65. Start at 45, and you’d have £550,000.
Start at 40, however, and you’d have a whopping £870,000 by 65. That’s obviously far more money for retirement.
What’s crazy is the difference between starting at 40 and 45. Despite putting just £48,000 more in over the five-year period, the pot would have an extra £320,000 in it by 65.
This illustrates the importance of starting early. The earlier you start, the more time you have to capitalise on the power of compounding (earning a return on past returns).
Generating solid returns
Now obviously, the 8% return plays a key role in these calculations and that’s in no way guaranteed. Many investors achieve less. So, how does someone aim to achieve that level of return over the long term?
Well, there are few strategies an investor could consider.
One is investing in a low-cost index fund. An example is the Legal & General Global Equity UCITS ETF (LSE: LGGG).
This is a simple tracker fund designed to mimic the performance of the Solactive Core Developed Markets Large & Mid Cap USD Index. In other words, it provides exposure to large and medium-sized companies in developed markets.
Overall, it provides access to around 1,400 stocks. Among the top 10 largest holdings are Apple, Nvidia, Microsoft, and Amazon.
This fund has performed very well over the last five years (to the end of February), returning about 14% per year. However, I wouldn’t expect that kind of return to continue.
Over the long run, these kinds of index products tend to return more like 7%-10% a year (assuming no big currency movements). If economic conditions are weak, or geopolitical issues scare investors, returns could be lower.
Aiming for higher returns
Another option to consider is putting together a portfolio of individual stocks. This is a riskier approach to investing but could lead to higher end results.
Just look at the returns generated by Amazon shares (which I think are worth considering today) over the long run. Over the last decade, they’ve risen about 880% or 25% per year (in US dollar terms).
That’s a brilliant return. But investors have had to put up with plenty of volatility along the way.
It’s worth pointing out that these approaches aren’t mutually exclusive. Personally, I like to do both.
I have passive index funds for diversification and portfolio stability. I then have stocks like Amazon for extra growth.
This post was originally published on Motley Fool
