While younger investors often pursue growth-oriented investment opportunities, passive income shares can often be underestimated.
Despite not typically delivering explosive share price gains, income stocks can often achieve superior portfolio returns to growth stocks over the long term. And quick glance at the historical performance of the FTSE 100 make this very apparent.
Between 1984 and 2022, the UK’s flagship index achieved a 645% return from rising share prices. But when dividends are included in the equation, this gain more than doubles to 1,515%! To put it into perspective, that’s the difference between earning £6,450 and £15,150 from an initial £1,000 investment over the period.
Capitalising on the compounding returns of dividends is a proven strategy for building vast wealth. And given sufficient capital and time, generating an annual passive income of £59,000 isn’t as far-fetched as many would believe.
Dividend investing vs savings accounts
Today, the FTSE 100 index currently offers a dividend yield of approximately 3.8%. That’s a fairly generous level of income on a historical basis. However, following the recent interest rate hikes from the Bank of England, many savings accounts offer a similar rate at a far lower level of risk. So why bother investing?
Unlike the interest rate on a savings account, the returns generated by the stock market are rarely static. This volatility can obviously backfire, sending the value of an investment portfolio in the wrong direction. Yet, in the long run, a carefully constructed portfolio of high-quality businesses has the potential to vastly outperform.
Even if investors don’t have the time or skill to construct a solid portfolio, investing in a FTSE 100 index fund could still be the wiser option. At least, that’s the impression provided in AJ Bell’s latest dividend report which estimates lead index dividend payouts are on track to rise by 11% to £84.8bn this year before breaching £90bn in 2024.
Building a £45,000 passive income
A 1,515% gain over 38 years translates into an average annual compounded return of 7.6%. That may not seem like much more than a regular savings account. But over decades, a few extra percentage points can have a massive impact on wealth.
At this rate of return, investing £500 a month for four decades – the average number of years people work – would result in a portfolio worth approximately £1,555,720. Withdrawing the 3.8% dividend yield translates into an annual passive income of around £59,117. And that’s assuming the yield doesn’t increase in the future.
Needless to say, retiring on almost 60 grand a year sets the stage for quite a comfortable retirement lifestyle. Obviously, this wealth isn’t guaranteed. And volatility in the stock market may result in far less being achieved when the time comes to retire. But given the potential rewards, I feel it’s an endeavour worth the risks.
And the sooner an investor starts, the better the potential outcome can be.
