A cool quarter of a million pounds is quite a nest egg. While it may sound like the stuff of dreams, I think breaking a target down into a series of discrete steps can make it easier to achieve. Here is how I would aim to do that by investing a spare £500 each month in cheap UK shares.
Why I’d buy shares
There are a couple of ways in which buying shares could help me reach my target. One is capital growth – any increase in the value of cheap UK shares I buy during the time I own them. For example, if I buy shares I see as undervalued at £1 each and years later sell them for £3 apiece, I will have tripled my investment.
The second helpful contributor to my goal could come from dividends. Those are payments a company makes to its shareholders. If I invested £1,000 in shares today with what is known as a 5% dividend yield and the company maintained its dividend, I should receive £50 in dividends year after year as long as I owned the shares.
Aiming for the target
If I was able to use a growing cash pile to achieve capital growth and dividend income, that could help me achieve my goal. In fact, I could reinvest the dividends – something known as compounding. That could mean I was investing more than £500 per month without having to raise my monthly contribution.
But there are a couple of caveats. Share prices can go down as well as up, so capital growth is not guaranteed. Similarly, dividends are never a given. Even a highly profitable company that has paid big dividends regularly can change its priorities and decide to stop paying profits to shareholders.
Risk and reward
So what should I do? My approach would be to try and make the plan work for me, while trying to limit the downside risk. To do that, I would only invest in companies I felt I really understood. Companies publish their annual report and accounts, so I should be able to learn a lot about firms just by reading those documents.
I would then look for specific factors I felt could help a company grow profits in future, such as a strong position in a growing market, or a unique technology that meets a key customer demand.
I would also rule out companies if they had risks I did not like. For example, a balance sheet burdened with too much debt could make me decide not to buy shares, even if the business had attractive features.
Can cheap UK shares add up to £250,000?
Imagine that the value of my portfolio compounds by 12% each year. That could be from capital growth, dividends, or a combination of both. If I continue investing £500 a month, I should have built my portfolio value to £250,000 in under 16 years.
Compound annual growth of 12% is more challenging to achieve year after year than it may sound though. Shares like Persimmon currently yield over 12%, but if the economy worsens, dividends could fall. A recession could also hit growth prospects at some companies.
So although I do think I could possibly hit my target, I will need to choose shares carefully when investing my money!
The post I’d buy cheap UK shares with £500 a month to target a £250,000 nest egg appeared first on The Motley Fool UK.
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C Ruane has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.