People who are hoping to live comfortably off the State Pension in retirement may be disappointed. It amounts to just £8,767 per year, which is around a third of the average annual salary in the UK. As such, saving for retirement could be a worthwhile move.
However, with interest rates low at present, it’s difficult to obtain an income return of over 1.5% from a Cash ISA. Therefore, investing in FTSE 100 dividend shares could be a sound move, with a large number of them offering dividend yields in excess of 5%, even after the index’s gains in recent months.
FTSE 100 dividend stocks
In fact there are currently 29 FTSE 100 stocks that offer dividend yields in excess of 5%. Certainly not all of those companies may be worth buying, and there’s much more to selecting income shares than a high yield. For example, dividend affordability and dividend growth potential may be highly important.
However, the yields available on FTSE 100 dividend shares mean an investor may be able to generate an income in retirement from more modest sums of capital than they may realise.
For example, assuming a 5% dividend yield is achieved on capital invested in the FTSE 100, an individual would need to have a £175,000 portfolio to match the State Pension’s income each year. While that’s clearly a large amount of money, if even modest numbers are invested in a range of companies during an investor’s lifetime, it may be surprising how much capital can be accumulated for retirement.
By contrast, equalling the State Pension’s income from a Cash ISA would require around £585,000 to be invested. This is 3.3 times more than would be required to achieve the same level of income from investing in FTSE 100 dividend stocks.
Furthermore, generating a nest egg through saving in a Cash ISA during an individual’s lifetime may be more challenging than having a Stocks and Shares ISA that invests in the FTSE 100. Over the long term, a Cash ISA’s returns could lag inflation and reduce spending power, while the FTSE 100 has a solid track record of delivering total returns that are in the high-dingle digits.
Although the FTSE 100 has risen significantly since the start of the year, the index continues to offer good value compared to historic levels. It trades only several hundred points higher than it did almost 20 years ago, while having a range of members with 5%+ dividend yields indicates that there could be wide margins of safety on offer.
Therefore, now could be a good time to invest in FTSE 100 stocks, whether before or during retirement. They could offer a significantly higher return than a Cash ISA, and lead to greater financial freedom in retirement. Although there’s scope for short-term volatility, diversifying across a variety of stocks over the long term could lead to a favourable risk/reward ratio.
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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.