Savers continue to complain noisily about near-zero interest rates, with the average easy access account paying just 0.36%. However, they shouldn’t complain too loudly because there is a far more rewarding alternative to cash, if you are prepared to take a bit more risk. The FTSE 100 benchmark of top UK stocks is set to yield a juicy 4.1% this year, more than 10 times as much. Next year, it will be even better.
Reap the dividend
It is almost impossible to exaggerate the importance of dividend income for people who want to build their wealth and achieve financial independence. Dividends are the regular payouts companies make to reward investors for holding their stock, and the benefits roll up dramatically over time.
The latest Dividend Dashboard from online platform AJ Bell shows the FTSE 100 should yield a mighty 4.1% in 2017, a figure that should then reach an even more tremendous 4.4% in 2018. And I would expect it to keep climbing for year after year following that.
Top UK stocks such as BP, Centrica, GlaxoSmithKline, HSBC Holdings, Marks & Spencer and Vodafone now yield anything between 4% and 7%. As if that wasn’t enough, most companies aim to increase their payouts year after year, which means you are buying into a rising income stream. Some 26 FTSE 100 firms have increased their dividend every year for past decade. That simply doesn’t happen with savings accounts.
You can compound your good fortune by automatically reinvesting your dividends to buy more stock. This is when you start to make serious long-term money.
Sometimes the FTSE 100 rises, sometimes it falls, sometimes it is flat. Whatever happens, the dividends flow. If you reinvest them back into your FTSE 100 unit trust tracker or exchange traded fund (ETF), you will make money no matter what happens to the headline figure.
Many happy returns
Just look at this calculation from Schroders. If you had invested £1,000 on 30 December 1999 in the FTSE 100, capital growth would have produced a notional return of just £9.70 by last year. On a total return basis, with all your dividends reinvested, your £1,000 would be worth £1,796.
Consensus figures suggest the FTSE 100 will pay dividends worth £85.3bn in total this year, an increase of 16% on 2016. Effectively, the index is giving investors a 16% pay rise, something your boss is definitely not going to do. Total payouts are expected to rise another 8% in 2018, to a massive £91.6bn.
There is one shadow over this terrific dividend story. UK company profit forecasts are currently being cut, reducing the flow of cash that companies rely on to increase their dividends. Dividend ‘cover’, which shows how many times over the profits could have covered the dividend, is currently just 1.66 times profits. Ideally, it should be 2 times.
This is a minor quibble. Dividend growth may slow in future, but that is always the risk you take. Dividends are not guaranteed. In good times, companies pay higher dividends. In troubled times, they may cut them back, or scrap them altogether, although typically only as a last resort.
For now, investors are set fair. Even if dividends are trimmed at some point, they will still pay you far, far more than cash will.
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Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended BP and HSBC Holdings. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.