With a view to supplementing the State Pension, I have a Stocks and Shares ISA. Due to its attractive tax breaks and generous annual allowance, I reckon it’s an excellent investment vehicle for those looking to provide for a more comfortable retirement.
But how much is needed to produce an annual income of £12,548, equivalent to £1,046 a month, which is the same as the full State Pension? Let’s see.
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What returns are available?
At the moment (6 June), the UK’s major stock market indices have dividend yields of at least 3%:
- FTSE 100 – 3.06%
- FTSE 250 – 3.53%
- FTSE All-Share – 3.12%
But these averages include some companies that pay less generous dividends, or none at all. Exclude these and the figures become very exciting. For example, the top 50 are currently averaging 10.5%.
With this level of return, a Stocks and Shares ISA would need to be valued at £119,505 to reach our income target of £1,046 a month.
Personally, I think this would be a very welcome addition to the State Pension. I reckon it would go a long way to giving someone a more financially comfortable retirement. But how could an individual seek to build an ISA worth this much?
Some important numbers
For most people, investing little and often is likely to be the answer. As an illustration, putting £150 a month into an ISA — at an annual return of 7% — would grow to £118,120 after 25 years.
However, I reckon it’s possible to achieve a better return by adopting a stock-picking strategy.
Don’t believe me? Well, look at how this five-stock portfolio of FTSE 100 shares has performed since June 2021. I’ve picked well-known names from different sectors and, overall, they’ve delivered an average annual return of 19%.
| Stock | Sector | 5-year average annual share price growth (%) |
|---|---|---|
| Babcock International Group (LSE:BAB) | Defence | 28 |
| Barclays | Banking | 20 |
| Marks & Spencer | Retail | 18 |
| Shell | Energy | 17 |
| Halma | Technology | 13 |
| Average | 19 |
Investing £100 a month at 19% would create an ISA worth £482,451 after 25 years. Convert this into a portfolio of dividend shares paying 10.5% (no guarantees, of course) and it would be possible to generate an amazing £50,657 a year in retirement.
Right place, right time
Fortunately, I own the top performer on the list, Babcock International Group, the country’s second largest defence contractor.
Admittedly, the sector isn’t to everyone’s liking, which means there’s a smaller pool of investors to help drive Babcock’s share price higher. But we have to deal with the world as we find it rather than how we would like it to be.
And with NATO members, including Britain, pledging to spend 3.5% of GDP annually on core defence by 2035, the group could be one of the biggest beneficiaries.
Over the past four financial years, it’s increased its underlying operating earnings per share by 64%, improved its return on invested capital from 17.4% to 37%, and significantly reduced its net debt relative to EBITDA.
However, as a reminder of how operationally challenging the industry can be, it’s incurred an estimated £330m of cost over-runs on its Type 31 frigate contract with the Royal Navy during this period.
But with a trailing price-to-earnings ratio of 20.3, its shares are cheaper than those of its FTSE 100 rival BAE Systems (27.7). And with its strong balance sheet and large order book, I think Babcock’s a stock that could be considered by those looking to build significant long-term wealth to help fund their retirement.
Should you invest £5,000 in Babcock International Group Plc right now?
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James Beard owns shares in Babcock International Group plc and Barclays plc.
