With the income returns from Cash ISAs continuing to lag inflation, FTSE 100 dividend stocks could be a realistic alternative for long-term investors who are seeking to generate a passive income.
Since the index yields around 4.5% at the present time, obtaining an income return of at least 4% per year is unlikely to be a difficult task. Doing so could also mean that an investor has a diverse portfolio with relatively low company-specific risk.
Of course, there is the potential for capital loss when investing in FTSE 100 dividend stocks, while Cash ISAs carry no such risk. But in the long run, such a risk could be worth taking in order to obtain a higher income return.
There are a wide range of options within the FTSE 100 for investors who are seeking to generate a passive income. Sectors such as utilities, tobacco, resources, banking and property continue to be unpopular among investors, with their constituents offering dividend yields that are well in excess of 4% in many cases.
As such, it is unlikely to prove challenging for an investor to build a portfolio of 20 to 30 stocks in order to reduce overall risk, while still obtaining a dividend yield that is in excess of 4% per year.
By contrast, obtaining a 4%+ income return from a Cash ISA is impossible at the present time. The best rates are around 1.5%, and they are unlikely to move higher at a rapid rate over the medium term.
Interest rates are expected to remain low for the foreseeable future, with the UK facing an uncertain period as a result of Brexit. Moreover, the world economy may now be entering a period of looser monetary policy as economies such as the US look to stave off the potential threat of a slowdown.
Risk of loss
Clearly, investing in FTSE 100 dividend stocks carries the risk of losing money. In fact, an investor who buys a range of stocks is likely to experience challenges with one or more of them over the long run, and they may lose money on some of their holdings.
However, a diversified portfolio of FTSE 100 stocks appears likely to deliver total returns that are in the high-single digits over the long run. The index has a track record of generating such returns over a long time period, with it having always recovered from any recession or bear market that it has faced in the past.
Therefore, investors who have a long-term view may not be overly concerned about the short-term movements of their portfolio, since it is likely to move higher in value over the coming years.
With this in mind, the income return potential from FTSE 100 stocks versus a Cash ISA indicates that it offers a superior risk/reward ratio for investors who are seeking to obtain a second income from their capital.
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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.