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Looking for a passive income? I’d buy the FTSE 100 index

If you’re looking for a passive income stream, the FTSE 100 could help you hit this goal. The FTSE 100 is one of the most income-focused stock indices in the world. It currently supports a dividend yield of nearly 4.7%, which is higher than almost any other developed market stock index. And that’s not the Footsie’s only attractive quality.

Global income

The leading index’s dividend yield is an aggregation of all of the dividends of its constituents. So, in effect, 100 different companies contribute to the distribution.

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This suggests the dividend is also very sustainable. Indeed, for the yield to fall to zero, every member would have to eliminate their payouts. That’s unlikely ever to happen.

One or two companies might cut their distributions in a single year, but the diversified nature of the FTSE 100 suggests income investors have plenty of protection.

More than 70% of the index’s profits also come from outside the UK. What’s more, there’s not one single sector that has a disproportionate impact on the FTSE 100.

This diversification has helped the index navigate some tough times. For example, in 2008, when the banks were in trouble, mining stocks helped support the index. When the miners crashed several years later, consumer goods companies picked up the slack. Now banks are back in vogue (from an income perspective anyway).

Income and growth

The FTSE 100’s diversification has also helped the index’s growth, and this should continue. In theory, company earnings should expand inline with inflation at a minimum over the long run.

That suggests growth of 2% to 3% per annum over the long run. In theory, this earnings growth should have a knock-on effect on stock prices.

On top of this, there’s that 4.7% dividend yield. Added together, these figures suggest investors can look forward to a total return (income and capital growth) of between 6.7% to 7.7% over the long run.

These numbers are slightly below the FTSE 100’s historical average. The index has returned approximately 8% per annum since its inception. However, it’s always better to have a margin of safety when trying to estimate long-term market returns.

Index fund

Another advantage of using the FTSE 100 to generate a passive income is that it’s straightforward to track the index. There are FTSE 100 tracker funds on the market that currently charge less than 0.1%.

All these funds do is track the index, so there’s no risk of the fund manager picking the wrong stocks. It’s also helpful for investors who want to generate a passive income from dividend stocks, as picking income investments can be a tricky process.

The power of compounding

If you own a low-cost FTSE 100 tracker fund, all you need to do is sit back and let the power of compounding do its work.

For example, an investment of £20k in a FTSE 100 tracker, with additional contributions of £200 a month, could yield an investment pot of £136k after 15 years. That could be enough to throw off an annual passive income of nearly £8.2k a year, based on the FTSE 100’s current dividend yield of 4.7%. 

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Rupert Hargreaves owns no share 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.