As a long-term investor, a SIPP naturally appeals to me as an investment platform.
After all, a personal pension is something many people contribute to for decades – and that in turn could help fund retirement over the course of decades.
With the right approach, I think it is possible for an investor to turn a £100k SIPP into one that is worth over £1m in just three decades.
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So, someone in their early thirties today who puts £20k a year into a SIPP for the next five years could potentially retire with a SIPP valued at over one million pounds.
How did I figure that out? Simple – compounding £100k at 8% annually for 30 years would mean the SIPP grows in value to £1m.
Aiming for consistently strong performance
Incidentally, if that compound annual growth rate was just a bit higher (9%), the same timeframe would turn the £100k into £1.3m. Compounding really is powerful stuff, especially over a long timeframe.
But I will stick with the 8% figure as it is more easily achievable. It might not sound much: the FTSE 100 has risen 13% in the past year alone, as well as offering a dividend yield of 3.4%.
However, we are talking about a compound annual growth rate over 30 years – and some of those years may be very bad ones in the market.
Even taking the rough with the smooth, I think 8% is achievable. It could come from a combination of capital growth and dividends.
Maybe one share could deliver on it but that approach is unnecessarily risky. With £100k, a SIPP would have ample scope for diversification and any smart investor would take that approach.
Some of the shares picked would do better than others over time. But the point is to focus on buying a mixture of attractively priced shares in outstandingly good businesses that have promising long-term commercial prospects.
Is Diageo a bargain on a 30-year timeframe?
To illustrate, one share in my SIPP is Diageo (LSE: DGE).
At first blush, it may seem like an odd choice to try and demonstrate my approach above. Over the past five years, the Diageo share price has fallen 30%.
The dividend performance has been more reassuring, with the payout per share growing annually for decades. However, while the yield of 3.7% is attractive, taken together with the share price decline, it falls far short of the 8% compound annual growth I discussed.
However, past performance is not necessarily a guide to what to expect in future.
Diageo is going through a rough patch. While Guinness sales have been soaring, many of the firm’s spirits brands have been finding current market conditions tough. They could get tougher, due to consumers reining in spending and younger generations drinking less alcohol than their forebears.
Still, I reckon the alcohol market will remain strong in the long term. Diageo’s premium brand portfolio gives it pricing power. That helps is profit margins and cash generation, in turn funding the dividend.
Its brands and facilities, like Talisker distillery, are unique assets, giving Diageo what I believe to be a sustainable competitive advantage for the coming decades. That is why I have been buying what I see as a blue-chip bargain for my SIPP this year.
