I’m working hard to generate a passive income in retirement, on top of whatever the state pays me, and I think FTSE 100 dividend shares are the best way to do it. Now is a particularly good time to buy them, as share prices fall and yields rise as a result.
Investors are gloomy today as interest rates look set to stay higher for longer, and the Middle East burns. However, markets rarely stay down for long, so I’m buying shares today in the expectation that at some point they’ll bounce back.
So many shares to buy
If I had enough money to use up my full £20,000 Stocks and Shares ISA allowance this year, I’d be loading it up with UK blue chips.
I’d target dirt-cheap dividend shares like insurer Aviva, mining giant Rio Tinto, and wealth manager M&G. They currently yield 7.81%, 8.22%, and 10.14%, respectively. This level of income absolutely smashes cash, plus there’s potential for share price growth when stock markets finally recover.
Dividends are more rewarding than savings accounts but also riskier. If the company cannot maintain profits and cash flows, it may be forced to slash shareholder payouts or abandon them altogether. I’d reduce the risks by building a diversified portfolio of around 15 FTSE 100 shares, across a range of different sectors.
With luck, my dividend income will steadily rise over time, as companies look to increase their dividends and keep shareholders happy.
I reckon it’s possible to generate a passive income stream of around £10,000 a year, from my initial £20k. I’ll have to be patient though.
I only ever buy shares with a minimum 10-year view. By holding for the long term, I can withstand short-term market volatility, and give my reinvested dividends plenty of time to compound and grow. Later, when I retire, I will draw them as a second income.
The FTSE 100 has delivered an average total return of 8% a year since the 1980s. If my portfolio matches that, in 25 years my £20k will have grown to a pretty nifty £136,970.
When to start? Today
If my shares yield an average of 7% at the time, that would give me income of £9,588 a year. Not bad considering I only invested £20k.
These sums are a bit rough and ready. My hand-picked portfolio could grow slower than 8% a year so I’d end up with less. Alternatively, my stock picks could outperform. That 7% yield isn’t guaranteed, either.
Another risk is that the stock market crashes just before I retire, reducing the size of my pot. But history shows that in the long run, equities usually outperform cash. Whatever happens, I think the underlying argument holds good: building a portfolio of income paying shares is a great way to fund my retirement.
The longer I can leave my ISA invested, the more time it has to growth. So I won’t waste time, and I’ll start building tomorrow’s passive income stream today.
