On the one hand, generating a strong income from savings is incredibly challenging at the present time. Interest rates are near historic lows, with the best interest rate on savings accounts currently being around 1.5%. Given that this is 90 basis points below inflation, it lacks real-terms return potential over the medium term.
On the other hand, generating an above-inflation income return has arguably never been easier. The FTSE 100 currently yields in excess of 4% following its recent correction. In fact, it is possible to obtain an average yield of over 5% from a range of FTSE 100 shares – many of which also offer dividend growth potential. As such, I think income investing could have significant appeal at the present time.
Of course, it could be argued that FTSE 100 shares lack the stability of other assets such as bonds and cash. The value of shares can decline significantly, and the outlook for the UK and world economies continues to be uncertain. Just as the index has fallen by over 10% from its all-time high in May, further declines could be ahead. As such, what an investor gains in the form of a high yield could easily be fully offset by a fall in capital value.
However, shares could also offer growth potential. Given that the FTSE 100 has a 4%+ dividend yield, it could offer good value for money. Its yield is relatively high when compared to its historical levels, and this could indicate that it offers a margin of safety.
In contrast, investors holding cash or even investment-grade bonds may be unable to match inflation in terms of their income return. Since interest rates are forecast to deliver a modest rise in the next few years, this situation could remain in place over the medium term. And with bonds having the potential to decline in value as interest rates rise, it could be the wrong time in the economic cycle to be holding them.
Although shares have a riskier outlook than many other mainstream assets, their risk/reward ratio could be highly desirable at the present time. Certainly, the index has often been able to provide a worthwhile income for investors in the past, but at the present time there are clear risks facing its outlook. This could mean that when compared to other assets such as bonds and cash, there is a better-value investing opportunity on offer. In other words, the margin of safety available on FTSE 100 dividend shares could be greater than for other assets.
For investors with a long-term horizon, shares seem to offer a favourable risk/reward opportunity in my opinion. High yields, the potential for increasing dividends in a fast-growing world economy and wide margins of safety may mean that income investing may gain in popularity, with other options such as bonds and cash lacking return appeal at the present time.
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Peter Stephens has no position in any of the 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.