UK stocks are a brilliant way to invest for retirement because their dividends and share price growth can compound brilliantly over time. No less a genius than Einstein called compound interest the eighth wonder of the world, and it isn’t hard to see why. It can turn small sums into very big ones, given enough time.

Dividends are the regular payments companies make to reward investors for their loyalty. Many pay them even in years when the share price struggles to grow or even falls. They come on top of any capital growth investors generate when the company’s stock rises and can also help to compensate for share price falls.

A double wonder

They’re brilliant in two ways. First, most investors choose to reinvest them back into their portfolios while still of working age, which means they own more stock, which pays even more dividends, in an endless virtuous circle. Second, when the investor finally stops working, they can draw those dividends as a regular, rising income.

I say rising because most companies aim to increase their shareholder payouts over time. However, it’s important to remember that dividends aren’t guaranteed, and can be cut at any time. They can even be scrapped if the company doesn’t generate sufficient cash flows to fund them.

Since the 1980s, the FTSE 100 has generated an average total return of 8% a year assuming all dividends reinvested. Savings accounts may offer higher rates today than a few years ago, but they can’t match that.

Let’s say I invested £3 a day, which is roughly the price of a cappuccino. Then let’s assume I increase that sum by 5% every year, to keep up with rising prices (the price of that cappuccino will rise too).

If I keep that up, and generate 8% a year, how much I end up with will depend on how far I am from retirement. If I started at 25, and stuck to my guns, by retirement at age 68 I’d have a staggering £757,53. While that won’t have today’s spending power because of inflation, it should still be a pretty handy sum.

I pick my own stocks to earn more

If I didn’t start until 35, and was therefore 33 years away from retirement, I’d have £302,464 by  age 68. Investing £3 a day from age 45 would give me £110,374. As I said, compound interest is a wonder, but it does need time to work its magic. The earlier I start investing that daily £3 – or any other sum – the better.

I’d hope to generate more than 8% a year by investing in a portfolio of top FTSE 100 stocks that I select myself, rather than buying a tracker fund. After recent share price dips, the index is packed full of cheap stocks offering ultra-high yields.

I’ve recently bought Lloyds Banking Group, which pays income of around 6% a year, Legal & General Group, which yields 9.11%, and wealth manager M&G, which yields a staggering 10.59%.

Higher yields like these can be risky but having checked out these stocks, I think there’s a chance they’ll be sustainable. With luck I’ll get share price growth too when stock markets recover, putting me on course for a pretty handy retirement income.

The post If I invested £3 a day in UK stocks and got 8% a year I could have £750k at retirement appeared first on The Motley Fool UK.

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Harvey Jones has positions in Legal & General Group Plc, Lloyds Banking Group Plc, and M&G Plc. The Motley Fool UK has recommended Lloyds Banking Group Plc and M&G Plc. 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.