I’m keen to generate a second income in retirement and dividend-paying FTSE 100 shares are my method of choice. Equities have the power to turn a relatively small investment into something substantial, provided they are given plenty of time to compound and grow.
Stocks and shares offer two sources of return. The first is capital growth, when share prices rise. The second comes from dividends. FTSE 100 stocks offer some of the most generous dividend yields in the world. The average is 3.9%, but a score of stocks yield 5% or more (and one or two pay almost 10%).
While I’m working, I’ll reinvest all the dividends I receive straight back into my portfolio, to pick up more stock. At some point in retirement, I will draw them as passive income, to top up my State Pension and any part-time earnings.
Long-term plan
Everybody should keep some cash handy on easy access for emergencies such as car repairs or a boiler breakdown. However, the stock market is the best home for my retirement savings, as history shows that equities beat every other asset class, given time.
Equities can be highly volatile along the way though, so investors need to stick with it, even during troubled periods such as today.
If I was starting from scratch at age 25 and had £10,000 of investable cash, I’d buy individual stocks rather than a tracker. While the FTSE 100 has disappointed lately, plenty of top blue-chips have generated an outsize return.
I would start by investing £2k in a spread of five nicely valued dividend-paying stocks across different sectors.
Lloyds Banking Group, insurer and asset manager Legal & General Group and housebuilder Taylor Wimpey are favourites of mine. I might supplement them with mining stock Rio Tinto and utility National Grid.
I’ll enjoy retirement more
Today, Lloyds yields 5.03%, L&G 7.71%, Taylor Wimpey 6.39%, Rio 6.91% and National Grid 5.24%. The average yield is 6.26%.
Let’s say I got a tiny amount of capital growth too, and generated a total annual return of 7%, roughly in line with the FTSE 100’s long-term average. By age 68, my initial £10k would be worth an incredible £183,444, thanks to compound growth. If my shares still yielded 6.26%, that would give me dividend income of £11,484 a year.
If my portfolio did better and generated 10% average annual return, as I’d hope, I’d have £602,401 which would generate a blockbuster second income of £37,710.
A few provisos. First, over such a lengthy period, anything could happen. My holdings could scrap their dividends, their shares could crash and never recover, or they could go bust. Alternatively, they might do better than I hoped. There are no guarantees when investing.
One thing that’s certain is that income of £37,710 a year simply won’t buy as much stuff in 43 years’ time.
I’d get round these problems by topping up my holdings whenever I had cash to spare, and spread my money across a blend of FTSE income stocks. I’d still reinvest all my dividends.
I might not hit my second income target, but I should still enjoy a far more comfortable retirement than if I never tried.
