With the right choices and a long-term approach to investing, a SIPP can be a lucrative way to help fund retirement.
Admittedly, retirement may seem a long way away for many people, but in my opinion that is why it makes sense to act now! The further off retirement is, the more time one has to let money get to work in the SIPP.
As an example, here is how an investor could aim to turn a £50K SIPP into one worth five times that much.
Growing value while closely managfng risks
Few FTSE 100 shares yield 10.3%. But M&G (LSE: MNG) does and I feel it is worth considering.
If an investor put £50K into a share that yielded 10.3% and reinvested the dividends, after 17 years the investment would be worth over £250,000. If they waited just seven years more, it would be worth over half a million pounds!
SIPP SIPP hooray!
That demonstrates the power of long-term investing. But there are a couple of important points to note about this example.
First, I would never put all my SIPP in one share – it is important to be diversified as a way to manage risk.
Secondly, the 10.3% yield is unusually high. That can be a warning signal that the dividend may be cut in future. Some dividends get cut without any warning (hence the need for diversification).
Accumulating wealth in a SIPP is similar to doing it in an ISA. And just as with an ISA, it could be slow and steady or quick.
Compounding at 5% annually, for example, the SIPP would exceed half a million pounds in value after 33 years. At 15%, by contrast, it would take only 11 years (and after 33 would be worth £6.8m!)
Finding wealth-building shares to buy
I do think M&G faces risks. For example, the first half saw its policyholders withdraw more funds than they put into its main business. If that trend continues, it could eat into profits and the dividend could be at risk.
But the high-yield share also has a number of characteristics I typically look for when investing, such as a large market of possible clients, a big base of existing customers and a distinctive, well-known brand.
So although a high yield can be a red flag for investors, it does not necessarily mean that the dividend will not last. To try and understand that, I think it makes sense (indeed, is essential) to consider the commercial prospects of a firm over the coming years and even decades.
Past financial reports can provide some basis for that: things like the direction of travel for profit margins and whether sales are growing or shrinking. But it is important to face forward and consider what might change a company’s prospects in future, for better or for worse.
With the right research, buying excellent shares at a good price with a view to long-term ownership and managing risks carefully, I think an investor could realistically aim to turn a £50K SIPP into one worth a quarter of a million pounds, while sticking to blue-chip companies with proven business models.
This post was originally published on Motley Fool
