The rise of inflation since the EU referendum means that dividends are becoming of greater significance to many investors. Already, inflation has risen to 3%, and it is forecast to move higher. This could mean that many traditional income investing stocks become less effective at delivering a real income return. In fact, many of them may offer a negative real return over the medium term.
Since the FTSE 100 has a dividend yield of around 3.9%, it may prove to be a viable option for dividend investors who are concerned about inflation. In fact, in the long run the index could deliver high dividend growth too, which may help investors on their journey to a seven-figure portfolio.
The main reason for the FTSE 100’s bright dividend growth outlook is the exposure of its constituents. Around 70% of earnings generated by its members take place outside of the UK. This means that they are able to capitalise on growth opportunities abroad which may be superior to those found in the domestic market.
Regions such as Asia and Africa could offer high growth prospects for consumer goods companies, for example. This could translate into higher profitability which could mean that those companies with exposure to fast-growing regions may be able to raise dividends at a much faster pace than inflation.
Exposure to non-UK markets also decreases the risks involved with buying the FTSE 100 for its income appeal. With a resilient dividend being of great importance to income investors who rely on compounding to boost their portfolio returns, the FTSE having many companies with operations in the vast majority of the world’s regions may lower risk to a large extent. As such, from a diversification and risk perspective, the index may be a logical choice for long-term income investors.
The fact that over two-thirds of earnings are generated outside the UK by FTSE 100 companies also means that they could benefit from a loose monetary policy in Britain. Although interest rates were recently increased by 25 basis points to 0.5%, their upward trajectory in future years is likely to be relatively slow. The Bank of England seems to be concerned about the growth rate of the UK economy, and therefore it may opt to keep interest rates at a low level in order to avoid choking off the GDP growth rate.
A low interest rate, as well as uncertainty about Brexit as the March 2019 leave date comes closer, may mean that sterling remains weak. This could provide a positive currency translation boost for many of the FTSE 100’s constituents since although they generate most of their earnings abroad, many of them report in sterling. This translation gain may last over the medium term if Brexit remains a significant risk to the UK’s economic performance. As such, buying the FTSE 100 for its dividend outlook could be a shrewd move.
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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.