When I retire, I want to generate heaps of dividend income every month from FTSE 100 stocks and shares, to supplement my State Pension.
Building up a big enough portfolio to do that takes time, and I can’t always afford to invest my full £20,000 Stocks and Shares ISA allowance. Still, this year I’m hoping to scrape together £10,000, and while it won’t generate retirement riches on its own, it will take me a little closer to my goals.
Let’s say I’m 25 years away from my planned retirement date, and I invest £10,000 in a spread of five different FTSE 100 shares. Let’s also assume their performance matches the average total return on the FTSE 100 over the last 20 years, which is 6.89% a year. My £10,000 would have risen more than fivefold to £53,020 over those 25 years.
Investing for the long term
When working out how much income people can generate in retirement, financial planners use something called the 4% rule. This states that if a retiree withdraws 4% of their portfolio each year as income, their pot will never run dry.
If I withdrew 4% of my £52,020, I would generate income of £2,080 a year. That works out as almost £175 a month. I should still have my capital, which may even continue to grow.
If my portfolio yielded 7% a year – a rate of income that is perfectly possible from the FTSE 100 today – and I drew all my dividends instead, my annual income would increase to £3,641. That’s £303 a month. Drawing a higher rate of income is riskier, of course, so I would have to monitor my portfolio carefully to make sure the capital didn’t erode.
Decisions like these depend on personal circumstances, such as whether I want to leave an inheritance to any children or grandchildren, and so on.
Top income stocks to choose from
However, the real value of my divided income will have been eroded by inflation. That’s why I’m not just investing this year’s ISA allowance, but will continue to invest in future years.
Right now, there are loads of great value FTSE 100 dividend stocks to choose from. Lloyds Banking Group yields 5.25% a year and trades at just 6.4 times earnings. That’s cheap, given that 15 times earnings is traditionally seen as fair value, and the income looks set to rise over time. Moving up the yield scale, mining giant Anglo American yields 7.1% a year, and trades at just 5.6 times earnings
Housebuilder Barratt Developments yields 7.73% and trades at a bargain price of just 5.8 times earnings. British American Tobacco offers a thumping 8.18% yield and is valued at 7.1 times, while insurer Phoenix Group Holdings yields 9.14%. It also looks cheap trading at just 6.8 times earnings.
There is no guarantee these companies will deliver the growth and dividends I need. Dividends can be cut at any time, with high yielders notably precarious. Stock prices can fall. Sometimes they never recover. Companies can even go bust, although FTSE blue-chips are relatively secure.
By investing in a Stocks and Shares ISA year after year and diversifying to spread my risk, I can look forward to a healthy dividend income stream that grows over time.
