One of my nieces will be stepping aboard a Caribbean cruise ship next week. She’ll be working for seven months on the ship’s sports staff. She’s calculated she’ll earn £10,500 net and, with little time or opportunity for spending, plans on saving a big chunk of it.
At her age, 22, I didn’t give retirement and the State Pension a second thought. Had I done so, I’d have realised that if I wanted a financially comfortable retirement, I’d have to do something about. And that the sooner I started, the better.
The UK State Pension is currently just £8,546 a year (or £164 a week). My niece’s plans got me thinking. If she were to save £8,546 from her seven months’ earnings, how much might it be worth to her when she comes to retire?
Advice from the world’s most famous investor Over long periods, the stock market has outperformed other assets, such as cash, bonds and property — another thing I didn’t know at the age of 22. These days, its easier and cheaper than ever to invest in the stock market, thanks to low-cost index tracking funds. These funds simply mirror the return of the stock market (minus a very small annual charge).
The world’s most famous investor, multi-billionaire octogenarian Warren Buffett, has on many occasions recommended an S&P 500 tracker as the best investment for most people. This index consists of 500 US companies, weighted by size. You’ll be familiar with many of the names. The top 10 includes Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), JPMorgan Chase (NYSE:JPM), Johnson & Johnson (NYSE:JNJ) and Exxon Mobil (NYSE:XOM).
The S&P 500 is one of the longest-established indexes in its present form, making it useful for the question I want to answer. My niece will have 46 years to retirement, based on current projections of the UK retirement age. So the question is, if the S&P 500 delivers the same return in the next 46 years as it has in the past 46, what would it mean for her hypothetical £8,546 investment?
A far richer retirement According to a handy online calculator, the value of the S&P 500, including dividends, increased at a compound annual growth rate (CAGR) of 12.18% from the start of January 1971 to the end of December 2017. That turned $1 into $118.94. So an £8,546 investment would have grown to a massive £1,016,461.
However, we have to take into account 46 years of inflation to know the real value of that million quid. Accounting for inflation, the online calculator gives a CAGR of 6.49%, turning $1 into $19.20. So an £8,546 investment would be worth £164,083 in real terms. That’s still an impressive return.
Furthermore, on retirement, switching that £164,083 out of the index tracker into a portfolio of companies with high dividend yields averaging 5.2% (the likes of Shell (LON:RDSa), HSBC and National Grid (LON:NG) all currently yield between 5% and 6%), the £8,546 original investment could be providing an income of £8,546 and, hopefully, growing every year for the rest of your life.
Never too late Of course, stock market returns in the future may be better or worse than in the past. We can’t know for sure. However, if I were 22 again and had a lump sum of £8,546, I know for sure what I’d do with it. Indeed, whatever age you are, it’s never too late to begin investing to boost your income for retirement.
G A Chester has no position in any of the shares mentioned. John Mackey, CEO of Whole Foods Market (NASDAQ:WFM), an Amazon subsidiary, is a member of The Motley Fool's board of directors. The Motley Fool UK owns shares of and has recommended Amazon and Apple. The Motley Fool UK owns shares of Johnson & Johnson and has the following options: long January 2020 $150 calls on Apple, short January 2020 $155 calls on Apple, and short October 2018 $135 calls on Johnson & Johnson. The Motley Fool UK has recommended HSBC Holdings (LON:HSBA). 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.