I regularly contribute a small sum each month to my Self-Invested Personal Pension (SIPP) in preparation for my eventual retirement. While I still have a few decades ahead of me, I often wonder how much I could have made if I started a decade ago with £10,000.
The answer to this question very much depends on how the capital is invested. So let’s explore what sort of returns I could have achieved.
Index investing performance
First off, it’s important to highlight that investing using a SIPP comes with a major advantage – tax relief. Any capital injected into this special type of investment account gets a free top-up from the government as a sort of refund on any income taxes paid.
The amount of relief depends on an individual’s income tax band. However, assuming an investor is in the basic 20% rate bracket, that means their relief is also equal to 20%. As such, a £10,000 initial capital deposit is automatically topped up to £12,000.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Now, what about the gains that could have been achieved in the last decade?
Following along, the FTSE 100 over this period would have generated a 6.3% annualised return. This compounds to a total gain of 84.7% after the tax relief, placing the value of my portfolio at £22,168.
The FTSE 250 has faired slightly better. While it came with added volatility, the annualised returns achieved since 2013 reached 7%, elevating my investments to £23,689.
More than doubling my initial investment is certainly nothing to scoff at, especially when deploying a passive index investing strategy. But what if I had opted to pick individual stocks?
Risk vs reward
Hand-picking which companies to invest in can be risky business. It demands a far more hands-on approach to portfolio management versus an index fund. And the process of researching and analysing stocks is a time-consuming endeavour that requires a lot of pre-requisite knowledge.
A flawed analysis or overlooked threat can easily trick investors into buying low-quality shares, ultimately resulting in the destruction of wealth. Even top-notch companies can end up being a bad investment if the wrong price is paid. Consequently, a poorly prepared stock-picker can very often end up losing to the market, perhaps even ending up in negative territory.
But by taking a disciplined and informed approach, stock picking could pave the way to far superior gains. This is how investors like Buffett have historically generated close to 20% annualised returns. And at this rate, my £10k SIPP would be worth almost £62,000.
Of course, replicating Buffett-like returns is exceptionally difficult, even for professionals. However, just an extra 3% can make an enormous difference. At a 10% annualised rate of return, I could be sitting on a retirement pension pot of close to £26,000 today.
And if left for another three decades, it could potentially reach as high as £452,592!
