The Motley Fool

Building a second income? I’d buy FTSE 100 dividend stocks and hold them forever

Generating a reliable income return on capital has never been an easy task. As ever, the higher the potential return, the greater the risk of loss. However, at the present time, the opportunity to generate an inflation-beating income return on capital appears to be more difficult than ever.

Cash returns are 1.5% at best, while bond yields remain suppressed as a result of low interest rates. And with buy-to-let investing subject to tax changes, its net returns may be lower than they have been in the past.

As such, investing in FTSE 100 dividend shares could be the best way to build a second income. While not without risk, their return potential could make them the most appealing opportunity currently available to investors.

Low returns

As mentioned, saving through a Cash ISA is relatively unappealing at present. The highest returns available are lower than inflation, which means the spending power of savings continues to decline.

Likewise, investment-grade bonds offer disappointing returns. Low interest rates mean that gilts and higher-quality corporate bonds offer only modest income returns, while the prospect of rising interest rates means bondholders may experience a capital loss over the medium term.

Although it’s still possible to generate a relatively appealing gross income return on a buy-to-let investment, on a net basis it’s being put under pressure by tax changes. Many landlords are now unable to offset their mortgage interest against rental income, while the stamp duty surcharge on second homes means the cost of acquiring property has risen significantly in the last couple of years.

High returns

By contrast, the income returns on FTSE 100 shares continues to be high. The index has a dividend yield of around 4.5% at present, which is relatively high versus its historic range. In fact, the FTSE 100’s dividend yield has only been higher than its current level during times of severe strain, such as during the financial crisis, where the payment of dividends was highly uncertain. As such, it could offer exceptional value for money, as well as impressive income returns currently.

For investors who are comfortable in buying individual stocks, it’s possible to generate an even higher yield while also building a diversified portfolio. With 31 shares in the FTSE 100 currently having a dividend yield of 5% or more, obtaining a portfolio yield of 6% could be an achievable goal for many investors.

Risks

Although investing in FTSE 100 dividend stocks carries greater risks than cash or investment-grade bonds, its risk/reward potential seems to be more appealing. That’s especially the case for long-term investors, with the index having always recovered from short-term downturns and bear markets to post higher highs.

As such, for investors who are able to take a long-term view on their investments, buying FTSE 100 dividend stocks could be a shrewd move.

You Really Could Make A Million

Of course, picking the right shares and the strategy to be successful in the stock market isn't easy. But you can get ahead of the herd by reading the Motley Fool's FREE guide, "10 Steps To Making A Million In The Market".

The Motley Fool's experts show how a seven-figure-sum stock portfolio is within the reach of many ordinary investors in this straightforward step-by-step guide. Simply click here for your free copy.

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.