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Hoping to rely on the State Pension in retirement? I think the FTSE 100 could be a better move

Even though the State Pension was recently increased by 2.6%, it still amounts to just £8,767 per year. That’s less than a third of the average UK annual salary, and means that individuals who are hoping to rely on the State Pension in retirement may be disappointed with the spending power it offers.

As such, building a retirement portfolio made up of FTSE 100 shares could be a worthwhile move. The index appears to offer capital growth potential, as well as income investing prospects in retirement. While it can experience periods of disappointing performance, in the long run it may generate impressive total returns.

Capital growth

Despite experiencing a decade-long bull market, the FTSE 100 could offer significant capital growth over the long run. As an internationally-focused index, it may benefit from the continued growth in wealth in emerging economies such as China and India. A number of the FTSE 100’s constituents have exposure to such economies and may therefore experience a tailwind over the coming years.

Furthermore, the index doesn’t appear to be overvalued at present. In fact, it trades only around 10% higher than it did at the end of 1999. This suggests the current bull market could have some distance left to run, with a 4% dividend yield indicating there may be margins of safety on offer among a variety of industries and stocks within the index.

In terms of its capital growth potential compared to other mainstream assets such as bonds and property, the FTSE 100 appears to have relative appeal. Bond prices could be hurt by rising interest rates, while tax changes on property could limit its appeal. By contrast, the FTSE 100 seems to have strong growth prospects and yet trades on a fair valuation compared to other assets that may realistically form part of a retirement portfolio.

Income return

As well as its capital growth prospects, the FTSE 100 also offers an impressive income investing outlook. As mentioned, it yields around 4%. However, it’s possible to generate a significantly higher dividend return at the present time. In fact, around a quarter of the FTSE 100’s constituents have dividend yields of 5% or more. This means an investor may be able to build a diverse portfolio of income shares that together have an average income return of 5% per annum.

Should an investor be able to generate that sort of return from their portfolio of FTSE 100 shares, they may be able to significantly improve upon their State Pension in older age. This could lead to greater financial freedom, with a number of FTSE 100 companies having long track records of sustainable dividend growth. Although their share prices may fluctuate and could even experience downturns over the medium term, they may be the most efficient means of generating a higher income return in retirement.

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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.