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I’m targeting a large second income for when I eventually retire. So I invest the vast majority of my leftover cash each month in UK shares, trusts, and funds.
Like most people, I deposit some money in a savings account to provide a guaranteed return and give me funds for a rainy day. However, putting too much in a low-yielding cash product can also be high risk for those like me who are targeting a comfortable retirement.
Here’s why.
Cash returns
Today the best-paying, easy-access Cash ISA offers a 5.1% interest rate. That’s not bad, and certainly in the context of the poor rates that savers endured during the 2010s.
But parking all or most of one’s cash here could — depending on our investment goals — be a serious mistake.
On average, Brits currently save approximately £105.43 per month, according to personal finance website Finder. They also have £17,773 set aside in savings.
If someone parked this in a 5.1%-yielding Cash ISA, after 30 years they’d have £171,199 sitting in their account, excluding fees. If they then drew down 4% of this a year, they’d have an annual passive income of just £6,848, excluding the State Pension.
Given the rising cost of living and social care, it’s unlikely this will be enough to retire comfortably on. And what’s more, securing a 5.1% savings rate for the next three decades may be a tall order, depending on future interest rates.
A £17k+ passive income
Past performance is not a reliable guide to the future. However, the superior long-term returns of share investing since the mid-20th century suggest this could be a better option to consider to build wealth.
Let’s say an investor put £20 a month in that 5.1% Cash ISA, and the remaining £85.43 in a diversified mix of stocks, funds, and trusts in a Stocks and Shares ISA.
Based on a reasonable average annual return of 9%, and assuming that £17,773 of savings is also invested in the stock market, this investor could make £435,162 after 30 years.
A 4% drawdown in this situation would then provide an annual passive income of £17,406. These figures exclude broker fees.
A top trust
There’s no one answer to how much we’ll need to retire comfortably. This is highly subjective, while the future cost of living is also tough to predict.
But prioritising investing over saving can significantly improve one’s chances of building a decent nest egg. And one way to consider to achieve this is by investing in a fund.
The Xtrackers MSCI World Momentum ETF (LSE:XDEM), for instance, is a fund I’ve bought for my own portfolio. While it can go up and down in value according to economic conditions, its holdings in around 350 companies allows investors like me to spread risk while also targeting a large return.
Just under a quarter of the fund is sunk into high-growth information technology stocks like Nvidia and Apple. It also provides weighty exposure to the telecoms, financials, consumer goods, and industrials segments, reducing its dependence on one sector.
Since its launch in autumn 2014, this exchange-traded fund (ETF) has served up an average annual return of 11.52%. That’s higher than the 9% average that I mentioned above. If the fund continues to achieve a higher return, it would allow an investor to build a larger nest egg over time.
