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No savings at 40? I’d buy cheap FTSE 100 dividend stocks to retire on a passive income

Investing in undervalued FTSE 100 dividend shares today could improve your retirement prospects. The track record of the FTSE 100’s returns shows the reinvestment of dividends has made up a significant proportion of its total returns since inception.

Therefore, focusing your capital on companies that offer high income returns, as well as low valuations, could enable you to build a generous nest egg from a standing start at age 40 that provides a growing passive income in older age.

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Capital growth potential

The FTSE 100’s dividend yield of 4.4% means it’s likely to appeal to income-seeking investors at the present time. After all, it’s only possible to receive a fraction of that figure from other income-producing assets, such as bonds and cash.

However, the index also offers long-term capital appreciation potential for investors who don’t yet require a passive income from their portfolio, and who are seeking to build a generous retirement nest egg over the long run.

In fact, the FTSE 100 has returned around 9% per annum on a total return basis since it was established in 1984. A large portion of those returns have come from the reinvestment of dividends – especially over the past two decades where the index’s capital returns have amounted to just 10%.

As such, investing in a selection of FTSE 100 income shares today and holding them for the long run could lead to a surprisingly large retirement portfolio.

Valuations

The FTSE 100’s dividend yield suggests the index currently offers good value for money. It’s higher than its long-term average, and means investors may be able to generate impressive returns from the index in the coming years.

Furthermore, the valuations of many of the index’s members are currently below their historic averages. Banks, housebuilders, retailers and industrials companies are just some of the sectors which contain a range of stocks that appear to trade on wide margins of safety at the present time. Buying them now could, therefore, prove to be a sound means of capitalising on the index’s cyclicality.

Risk management

In addition to seeking high-yielding stocks which trade on low valuations, diversifying across a range of geographies and sectors could enhance your long-term return potential. In doing so, you’ll reduce your reliance on specific stocks to catalyse your retirement portfolio, which could increase your chances of generating a substantial nest egg from which to draw a passive income in retirement.

With the FTSE 100 including a range of companies that operate in a multitude of sectors and geographies, the process of diversifying is relatively straightforward. With a 40-year-old investor having a long time horizon until they’re likely to retire, now could be the right time to start buying undervalued FTSE 100 income shares to produce a nest egg 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.