The secret to how YOU can retire with a million pounds worth of investments: It may sound like a pipe dream, but with careful planning it’s more achievable than you might think…

BUILDING a million-pound investment portfolio for retirement may sound like a glorious utopia. It can’t happen overnight, of course, but with careful planning and regular saving, it’s more achievable than you might think.

Savvy investors can boost their investments by harnessing the power of dividends by reinvesting them over time rather than spending them. An investor who has sunk £500 a month into the UK stock market for the past 40 years would now have a pot of £1.4 million, but that’s only if they reinvest the dividends they’ve received.

Without this information, it would be worth a less impressive £506,000, according to investment platform Bestinvest.

The current high yields in the UK mean that a million pound pot is possible for those with time on their side, and who pick the right funds to benefit from the magic of compounding. This is the snowball effect that increases the value of portfolios as money is reinvested.

The UK stock market is a great hunting ground, with shares sometimes yielding more than 9 per cent. That means you’ll get £9 a year for every £100 you invest.

These payouts have accounted for more of the returns for UK investors than any share price growth. Jason Hollands of Bestinvest says: ‘If these are reinvested in equities rather than banked, the effect is particularly powerful.’

So how do you get started today if you want to make that million pounds? Many household name UK companies offer dividend payouts that far exceed the returns from a bank account.

These include insurance companies Legal & General and Phoenix Group, which yield more than 9 percent. An annual return of 9 percent would make you a million-pound portfolio in just 31 years, but Hollands warns against choosing only the highest-yielding stocks now and expecting to become a millionaire over time.

“It is unwise to select a fund or stock solely on the basis of a high dividend yield without first checking that the dividend is adequately covered by earnings and that there is no risk of the dividend being cut,” he says.

Instead, he suggests starting by using funds that invest in high-yielding stocks with strong business prospects to build a million-pound portfolio. And always make sure you’ve ticked the right boxes to ensure your dividends help your money grow.

Make a plan you can stick to

Becoming a dividend millionaire is a long-term endeavor. Make sure you set everything up right from the start so your money has the best chance of growing over time.

This means choosing an investment platform that gives you access to the funds you buy and keeps costs as low as possible.

Next, set up a regular payment to your chosen funds, making sure you have ticked the correct boxes so that the dividends are reinvested.

Most platforms allow you to set preferences to automatically reinvest dividends paid out through exchange-traded funds, stocks or investment trusts.

If you buy other types of funds, make sure you choose the ‘accumulation’ units rather than the ‘income’ units of the fund. This means that any income paid from these units will automatically be reinvested.

To avoid dividend tax, which is charged at 8.75 per cent on dividends over £500 for basic rate taxpayers and 33.75 per cent for higher rate taxpayers, you can set up an Isa for your dividend portfolio.

Choose the right funds for safe returns

While buying individual high-yielding FTSE 100 shares is a tempting way to benefit from the compounding effect of dividend payments, there is a danger that the companies behind these shares will stop paying dividends and that yields will decline over time.

“Dividend yields are not fixed and vary from year to year based on stock price and actual payouts,” Hollands cautions. If you buy individual stocks with high yields, check the company’s ability to pay its dividends using a measure known as “dividend coverage.” This divides earnings per share by dividends per share and shows how often a company can afford to pay its dividend out of its profits. A low measure suggests a company could get into trouble or cut its dividend later.

Buying a high-yielding fund or series of funds can be a safer way to build your portfolio.

Alex Watts, data and fund analyst at investment platform Interactive Investor, says active managers who focus on dividend-paying companies can ensure they are “financially healthy and generating sufficient cash flow to maintain or grow distributions”.

He suggests investing money in Artemis Income, which yields 3.4 percent but also focuses on capital growth. The fund is up 27 percent over the past three years and also distributes cash. “The fund’s management has a clear mantra of ‘cash flow first, dividends second’: in short, they prefer to own companies that can consistently generate strong cash flows, which is essential to boosting the dividends that shareholders receive,” he says.

Laith Khalaf, senior financial analyst at investment group AJ Bell, suggests buying the City of London investment trust, which focuses on dividend growth. The trust yields around 5 percent per year and has seen 57 consecutive years of dividend increases.

The fund, which has grown by 26 percent over the past three years, has been run by Job Curtis since 1991 and focuses on large-cap UK companies.

Rob Burgeman, senior investment manager at wealth manager Brewin Dolphin, suggests Murray Income, another investment trust. He thinks these trusts, which are listed and can retain some profits in good years to pay out in lean times, are attractive to anyone looking to build a dividend portfolio.

He says: ‘They hold substantial reserves to spread the income they generate through difficult periods. Many of them are considered ‘dividend heroes’ because they have increased their dividends every year for 50 years or more.’

Murray Income has returned 281 percent of its capital over the past 35 years. But with dividends reinvested, the return was 1,498 percent, Burgeman says.

The fund focuses on large British companies such as Unilever, AstraZeneca and RELX.

Use a pension to save faster

By harnessing the power of your pension, you can become a millionaire much faster. This is because the government gives tax relief on all contributions you make at your marginal income tax rate, regardless of whether you are a basic, higher or additional rate taxpayer.

A monthly contribution of £500 to a Sipp will earn you £250 in tax relief for those paying 40% tax. Add this up and assume 6% annual growth, with dividends reinvested, and you’ll be a millionaire in 35 years.

If you could achieve a 9% return – as offered by the current yields on stocks like Phoenix and L&G – you could reach the magic million in less than 28 years. Of course, this all depends on no major changes in the next budget.

Use the power of time to grow wealth

Albert Einstein called compounding “the eighth wonder of the world.” And you may find plenty to admire in the cumulative power of reinvesting dividends.

If you hold on to your investments for decades, you could end up with a large amount of money before you retire, most of which will come from dividends, not from stock price growth.

Exchange codes

Artemis Revenue: B2PLJJ3

Murray Income: 0611112

City of London Investment Fund: 0199049