Passive index investing‘s grown in popularity in recent years and I can certainly see the appeal. It’s low-cost, minimal hassle and can produce a respectable second income if the index pays a decent yield.
The FTSE 100‘s known for its high dividends. So how much could I expect to get back each year if I put the entire £20k annual Stocks and Shares ISA into a tracker fund? Let’s take a look.
The current FTSE 100 dividend yield’s 3.56%. This is based on the current share prices and the total dividends declared by the constituents in the previous 12-month period.
However, this doesn’t include special dividends. These are when a firm has excess cash (from say an asset sale or exceptional earnings) it wants to distribute to shareholders. They tend to be one-off payments. For example, I got a special dividend from HSBC in June following the disposal of its Canadian business.
Adding those in bumps the FTSE 100 yield up to 3.75%. So when I invest in an exchange-traded fund (ETF) that tracks the Footsie, I should expect returns slightly lower after accounting for ETF management fees.
This assumes the yield remains constant, which isn’t guaranteed as dividends can be cut and share prices fluctuate.
Putting this together then, it means I could expect around £730 a year from a £20k investment.
Falling rates
Is that any good? Not particularly when interest rates are still pretty high. Investors holding cash can currently get a better return without the risk of losing capital were the FTSE 100 to experience a significant drop.
On the flip side, the FTSE 100 could go up. It’s risen 7.5% on a share price basis so far this year.
Interest rates on savings accounts are expected to drop significantly on anticipated rate cuts. My savings account with digital bank Tandem was paying me 5% interest. Now it’s 4.4% and will almost certainly head lower.
As and when the Bank of England cuts rates, the FTSE 100 yield should start to look more attractive.
Better strategy
However, some individual shares already do. In fact, a handful look positively mouthwatering.
| Dividend Yield | |
|---|---|
| Phoenix Group | 9.45% |
| M&G | 9.28% |
| Legal & General | 9.18% |
| British American Tobacco (LSE:BATS) | 8.51% |
| HSBC | 7.12% |
I already hold three of these (Legal & General, British American Tobacco and HSBC). If I were to invest my £20k evenly among these, the yield would average 8.27%. That means I could expect a second annual income of £1,654, rather than £730. More than double!
Of course, this involves taking on added risk from individual stocks like British American Tobacco. The firm’s facing a long-term decline in cigarette-smoker numbers globally. And while its non-smoking division, which sells vapes and pouches, is growing, it’s still uncertain if these will ever offset falling cigarette volumes.
For me though, these risks are more than priced into the stock. It’s trading on a rock-bottom forecast earnings multiple of 7.3. That’s incredibly low for a firm producing significant profits. After all, it’s unlikely smoking and vaping will disappear overnight.
In the next five years, the tobacco giant estimates it will generate around £40bn in free cash flow. That should be enough to cover the massive dividends it pays out to shareholders.
This post was originally published on Motley Fool
