Relying on the State Pension in retirement may lead to a challenging financial outlook in older age. After all, it amounts to just £8,767 per annum, which is around a third of the average salary in the UK.
As such, building a portfolio of stocks could be a sound move. They have the potential to generate a nest egg from which you can draw a passive income in retirement.
With the FTSE 100 currently yielding in excess of 4%, it appears to offer good value for money. Therefore, now could be a good time to start buying stocks for the long term.
Buying high-yield shares could be a sound means of generating impressive long-term returns. With the FTSE 100’s annualised total returns since inception being around 9%, and its dividend yield currently standing at 4.4%, a large proportion of its future returns could be derived from the reinvestment of dividends.
Therefore, buying income shares now and reinvesting the income they produce could prove to be a sound means of building a surprisingly large nest egg in the long run.
Clearly, identifying those companies that offer sustainable, as well as high, yields is likely to be highly important. As such, investors may wish to check factors such as a company’s track record of making shareholder payouts during turbulent periods for the world economy.
In addition, the headroom a company has when making its dividend payments and its management’s attitude towards paying excess capital to investors, rather than seeking to grow the business, could provide an insight into its future income prospects.
Clearly, dividend shares will not be immune to the inherent volatility of the stock market. Risks such as political uncertainty in the US and geopolitical challenges in the Middle East could cause dividend shares to post short-term paper losses for their investors. As such, less risky assets such as cash and bonds may appear to be more appealing in the coming months.
However, investors who have a long time horizon may benefit from holding income shares. Their return potential relative to less risky assets may mean that their rewards are worth their extra risks. And by diversifying across a range of stocks, it may be possible to reduce your overall risk without diluting your return potential.
Buying dividend stocks
Since it is relatively simple and straightforward to open a tax-efficient account such as a Stocks and Shares ISA, dividend shares are accessible to almost all investors.
With the FTSE 100 appearing to offer good value for money and there being a wide range of opportunities to generate impressive total returns among large-cap dividend shares, now could be the right time to start investing in income stocks to reduce your reliance on the State Pension in retirement and boost your financial prospects in older age.
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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.