Building a high and rising passive income looks like the key to a contented retirement, and my chosen way of doing this is to invest in FTSE 100 shares.
Stocks listed on London’s blue-chip index pay some of the most generous dividends in the world, with a forecast yield of 4.2% for 2024. While the US S&P 500 has smashed global markets in recent years, it only yields around 1.5%.
Dividend-paying UK shares are tempting for another reason. After relative underperformance, they seem cheap to me. A host of FTSE 100 stocks now trade at less than 10 times earnings, while yielding 5%, 6%, 7%, or more. Those are the companies I’m buying today.
Building from the bottom
With luck, I should get an extra lift when these stocks swing back into favour. Assuming they do, that is. There are no guarantees when investing. While I wait, I’ll reinvest all my dividends to boost the value of my stake.
I’d aim to spread my risk by building a portfolio of at least 15 FTSE 100 stocks, covering different sectors and with different risk profiles. If I was investing a £20,000 Stocks and Shares ISA right now, from scratch, I’d split it five ways between the following companies.
Lloyds Banking Group, wealth manager M&G, mining giant Rio Tinto, utility giant National Grid and, if I was feeling brave, telecoms giant BT Group.
As my table shows, BT, Lloyds and Rio Tinto are cheap as chips, as measured by their price-to-earnings (P/E) ratio. M&G and National Grid are trading around fair value having enjoyed some share price growth over the last year. All offer terrific yields.
| P/E ratio | Current yield | One-year performance | |
| BT Group | 6.2 | 6.36% | -6.83% |
| Lloyds | 6.5 | 5.04% | -2.17% |
| M&G | 15.4 | 8.66% | 14.22% |
| National Grid | 16.8 | 5.16% | 4.50% |
| Rio Tinto | 8.6 | 6.95% | -9.35% |
Those five shares would give me an average yield of 6.43%. With luck, that will rise over time as the economy recovers and their profits grow. The risk is that one or two can’t keep up, and cut their dividends. Or even go bust. It can happen.
Got to last the course
Now here’s the key factor. The one thing that determines how well I do above all others. My investment time frame.
The longer I can leave my money invested, the longer my dividends and growth have to compound and grow. So if I invested my £20k at age 25 and it delivers an average total return of 8% a year, I could have a staggering £547,333 by age 68. If my shares still yielded 6.43%, that would generate income of £35,194 a year. All from just one year’s Stocks and Shares ISA.
Obviously, there are plenty of provisos. My portfolio may not grow at 8% a year (although it could also beat that). My stock picks may not even exist by the time I hit retirement. Inflation will have eroded the real terms value of my money. I may have raided my pot for another purpose.
However, the principle holds. Start investing as early as possible and, most important of all, stick with it. Oh, and invest more than one year’s Stocks and Shares ISA allowance. The more income shares I hold, the merrier my retirement should be.
