Several sectors on the FTSE 100, including housebuilding, banks and financial services firms, are trading at significant discounts. And that’s music to the ears of value investors.
Despite performing better than the FTSE 250, the blue-chip index is flat over one year and five years. And it’s amid this underperforming index that I’ve been hunting for bargains with strong dividend yields.
So here’s why and how I’d start investing now to create a portfolio that could allow me to retire early.
How it works
To retire early I’m going to need my investments to provide me with enough income to live off before my pension kicks in. I’d suggest I need around £30,000 to live comfortably. I appreciate that’s not a huge amount, but if I can generate this money using my Stocks and Shares ISA, it’ll be tax free.
Generating £30,000 in passive income isn’t easy. Even when invested in some of the biggest yielding stocks on the FTSE 100, I’d need around £400,000 capital. Not all of us have that much money.
Obviously that sounds daunting. But we mustn’t be put off. It’ll take time, but as other articles on compound returns demonstrate, regular contributions and reinvesting can help turn a small pot into a giant one.
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Compounding
A compound returns strategy involves reinvesting my dividends and earning interest on my interest. Essentially, it’s very much like a snowball effect. And the longer I leave it rolling, the more I’ll have.
If I start with £40,000, with a compound returns strategy, and an annual growth rate of 10%, it’d take me 23 years to hit £400,000. I could reduce the time required to 18 years if I contributed £200 a month.
Buying now
I believe I can shorten the time it takes me to reach £400,000 by investing my capital now. That’s because I see significant opportunity in this current market to buy undervalued and high yielding dividend stocks.
Naturally, by buying undervalued stocks, I can hope to see greater upwards movement in the share prices going forward. Of course, there is no guarantee and the value of my portfolio could fall, but a value investing strategy has outperformed all major indexes since the Second World War. Equally, by locking in higher dividend yields, I can supercharge my reinvestment strategy.
One of my favourite stocks right now is Lloyds — despite the narrative that things will only get worse for banks when interest rates fall, which I disagree with. It trades at 6.3 times earnings, is potentially undervalued by 50%, and offers a forward dividend yield of 7%.
With a dividend yield around 7% and, hopefully, some upward movement in the share price, I’d be targeting total returns around 12%. There are other FTSE 100 stocks, such as Legal & General as well as FTSE 250 housebuilder Vistry Group, that I’d consider for this strategy too.
And by achieving annualised total returns of 12%, I could turn £40,000 into £400,000 in just 16.5 years, using the above compound returns model and contributing £200 a month.
