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Retirement may seem very far away, but it is getting closer every day. That's why, like many other investors, I'm putting money away in a SIPP to invest. Hopefully that can help me increase my retirement income.
As an example, let's imagine that I wanted to aim for a five-figure income when I retire in 30 years. How would you go about trying to achieve that goal?
Starting with the end in mind
To start, I would ask myself what it would take to achieve that goal.
How much I could earn in income would depend on how much I had saved in my SIPP and what the average dividend yield I would be earning might be after 30 years.
Dividend yields, generally speaking, rise and fall at different points in the business cycle. At the moment, some FTSE 100 share how Vodafone (LSE:VOD) have double-digit returns. But in the long term, I think you could realistically aim to earn 5% annually in dividends while still holding high-quality blue chip stocks. You may earn more than that, but 5% serves to illustrate the point.
Imagine also that I reinvest the dividends within my SIPP. After all, until a certain age I cannot withdraw money from the pension envelope.
If I invest £246 each month into my SIPP and earn an average dividend yield of 5%, compounding the payments over 30 years will give me a portfolio that will earn a five-figure annual dividend income.
Finding the right stocks to buy
But who knows what return you could get on a given stock five or ten years from now, let alone 30 years from now?
To some extent, my goal is to mitigate that risk by spreading my portfolio across a variety of high-quality companies.
But I still want to try to buy only what I consider to be excellent quality stocks, which are trading at attractive prices.
So does a stock like Vodafone meet my criteria?
It certainly has some of the attributes I'm looking for. It operates in a large market that I expect to benefit from significant and resilient demand. Within that market, it has some competitive advantages, such as a strong brand, a leadership position in multiple markets, and a large customer base. It could benefit from growing demand for mobile money in some of the African markets it serves.
However, there are risks that could lead Vodafone to cut the dividend again as it did several years ago (or even cancel it entirely, as Direct line did it last year). The company has a lot of debt, although it is decreasing. Asset sales in recent years could also result in lower profits.
Looking to the long term
Still, even considering the risks, I think the potential rewards of owning Vodafone shares are attractive to me. That's why I have them.
By building a diversified portfolio of high-quality shares in my SIPP, I hope to retire with a five-figure annual dividend income. The time to focus on making that happen is now – the sooner the better!
