£25k in savings? Here's how I would try to turn that into an income worth £12k a year

When I retire, which I expect will be at least a few decades from now, I hope to supplement my pension income with passive income from my Stocks and Shares ISA. Together, these benefits can make my retirement financially free and happy.

For the past decade, I have been investing in UK and US stocks as part of my strategy to build a portfolio large enough to support me in retirement. It goes without saying that the money invested at that time will add up over time.

However, millions of Britons are sitting on savings that will not deliver life-changing returns over time because of negative real rates. So with £25,000 in savings, I could look at spending that money investing in stocks and funds.

Although investing may sound too risky to many people, a diversified portfolio can help manage risk over time. Here's how to do it.

To reduce the risk

Funds, ETFs (exchange-traded funds), and trackers provide cost-effective ways to spread investment across multiple companies, sectors, and geographies.

This allows us as investors to minimize the impact of underperformance on any one investment. These instruments also allow investors to gain exposure to broader markets, perhaps balancing between US, UK, and global markets.

Historically, stock markets have shown strong long-term growth potential. From 1900 to 2023, US stocks returned 6.4% per year in real terms, while UK stocks returned 5.3%.

Looking at recent figures, the S&P 500, the benchmark for the US stock market, has delivered an average annual return of 10.7% since its launch in 1957.

This beats inflation and many other types of investments. We can get access to these returns by simply investing in tracker funds or buying shares in certain sector funds.

Taking this 10.7% rate of return and assuming I can multiply that over the coming decades, it would take me 20 years to turn my £25,000 into a portfolio that would bring in £12,000 a year.

A sensible choice

There are many ways to invest, and this depends on our circumstances and goals. Personally, given my expertise and the fact that I deposit money into my ISA every month, I prefer to pick one or two new stocks every month – I often re-pick.

However, if I were to start investing in bulk today, I would consider spreading my money across mutual funds and ETFs, such as Vanguard S&P 500 UCITS ETF GBP (LSE: WAKE UP).

It's among the most popular ETFs for good reason. It simply tracks the performance of the S&P 500 index, giving European investors easy access to the US stock market. It provides exposure to the 500 largest US companies, representing approximately 80% of the US equity market capitalization.

It also stands out for its low fees, with an average expense ratio of just 0.07%, much lower than most actively managed funds. It is highly liquid, making it easy for investors to buy and sell shares without incurring capital costs or buying costs.

Of course, even very different currencies can go down and up. Recessions, trade wars, and real wars can also have a negative impact on the performance of US stocks, as well as this ETF. However, short, medium, and long-term performance has been very strong.