Building a retirement portfolio that can provide a passive income in older age may sound impossible to someone aged 40 who has no savings. After all, a retirement nest egg needs to last for decades in many cases, such has been the improvement in life expectancy.
However, the task may not be quite as impossible as it seems at first glance. The investment capacity of the stock market could mean that even modest sums of money gradually become amounts that can provide a passive income. And, with the stock market also offering a relatively generous income return, it could prove to be a sound place to invest for an income once older age arrives.
Stock market growth potential
Investing in the stock market at the present time may seem to be a risky move. However, an investor aged 40 will have a couple of decades (or more) until they will retire. During that time, indexes such as the FTSE 100 are likely to produce annual returns that are in the high-single-digits.
Certainly, their performance from year-to-year is likely to vary wildly at times. In fact, in the last 20 years, the FTSE 100 has experienced two major bear markets that each sent its price level plummeting by around 50%. Despite them, it has recorded an annualised total return of around 9% since inception in 1984.
Assuming the same rate of return on a £100 per month investment over a 25-year period would give a nest egg of £101,000. Clearly, the more that is invested, the higher potential nest egg. As such, living within your means and aiming to invest as much as possible per year would be likely to have an even more positive impact on the size of your retirement fund.
Stock market income potential
Upon retirement, many investors have historically sought to generate a passive income from assets such as cash and bonds. At the present time, they offer rather disappointing income returns. In fact, in many cases they are less than 2% per annum. This means that you are likely to need a significant amount of capital to generate even a modest passive income in older age.
By contrast, the FTSE 100 currently has a dividend yield of around 4.5%. This could mean that a £101,000 nest egg in the above example offers an income return that is more than 50% of the State Pension each year. And, by investing more than £100 per month over a 25-year time period, you may be able to further reduce your reliance on the State Pension.
As such, investing in a diverse range of FTSE 100 shares to generate a passive income in older age could be a sound move. There may be volatile periods within your time horizon, but the track record of the index shows that it has been a worthwhile means of investing for retirement over a long time period.
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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.
Motley Fool UK 2019