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When I retire, which I expect will be within a couple of decades, I hope to supplement my pension income with passive income from my stocks and shares ISA. Taken together, this income could make my retirement more comfortable and financially enjoyable.
Over the past decade, I have been investing in UK and US stocks as part of my strategy to build a portfolio large enough to sustain me through retirement. Needless to say, the money invested over that period has compounded over time.
However, millions of Britons have savings that won't deliver life-changing returns in the long term because of negative real rates. So if I have £25,000 saved, I might try to put that money to work by investing it in stocks and funds.
While investing may seem inherently riskier to many people, a well-diversified portfolio can actually help manage risk over the long term. Here's how to do it.
Risk mitigation
Funds, ETFs (exchange-traded funds) and trackers offer cost-effective ways to spread investments across multiple companies, sectors and geographic regions.
This allows us, as investors, to mitigate the impact of poor performance from a single investment. These instruments also allow investors to gain broad market exposure, possibly balancing between US, UK and global markets.
Historically, stock markets have shown strong long-term growth potential. Between 1900 and 2023, US stocks returned 6.4% annually in real terms, while UK stocks returned 5.3%.
Looking at more recent statistics, the S&P 500, the benchmark index of the US stock market, has offered an average annual return of around 10.7% since its introduction in 1957.
This beats inflation and many other forms of investment. We can access these returns simply by investing in tracking funds or buying shares in specific sector funds.
Taking this 10.7% rate of return and assuming I can replicate it over the next few decades, it would take me 20 years to turn my £25,000 into a portfolio that could generate £12,000 a year.
A sensible choice
There are many ways to invest, and this depends on the circumstances and our objectives. Personally, given my profession and the fact that I invest money into my ISA on a monthly basis, I prefer to choose one or two new shares each month, often repeating the selection.
However, if I were to start investing with a lump sum today, I would consider spreading my money across funds and ETFs, such as the Vanguard S&P 500 UCITS ETF GBP (LSE:VUSA).
It is among the most popular ETFs for a good reason: it simply tracks the performance of the S&P 500 index, giving European investors easy access to the US stock market. It provides exposure to 500 of the largest US companies, which account for approximately 80% of the US stock market capitalisation.
It also stands out for its low cost, with an expense ratio of just 0.07%, significantly lower than that of many actively managed funds. In addition, it is highly liquid, which makes it easy for investors to buy and sell shares without incurring large spreads or transaction costs.
Of course, even the most diverse funds can go up or down. Recessions, trade wars and actual wars could also negatively impact the performance of US stocks and this ETF. Nevertheless, the short, medium and long term performance has been very solid.
