Years ago, I had no idea what kind of investing strategy would be the most successful in getting folk to a comfortable retirement.Â
But as I’m getting ever greyer, the answer is becoming strikingly clear. The most successful among my peers are those who long ago understood the long-term compounding power of reinvesting dividends. And they’ve mostly been investing in top FTSE 100 companies.
Suppose you invest in a stock that’s paying 5% in dividends. That’s a good yield, and we’re currently in times when I reckon you have a very good chance of achieving that level of annual income. After 20 years you’d have doubled your original investment if you’d just taken the cash.
Suppose instead, you reinvested the cash in more shares. And suppose those shares were appreciating in value by 5% per year (which is close to the FTSE 100’s long-term average). It would take only a little over 14 years to double your investment, and that’s quite a difference.
How long would it take to treble your money? Taking the cash out each year, it would take 40 years in all.
But would you believe that the extra power of reinvesting the cash would get you to the same total a whopping 17 years earlier, after just 23 years? And a 40-year investment based on reinvesting dividends would see you with seven times your original stake!
Can the FTSE 100 really do this for you?Â
Over the long term, the UK’s top index has typically provided average dividend yields of a bit under 3.5%. Added on to rising share prices, that’s pretty good, but right now we’re in a period of unusually high yields. According to the quarterly Dividend Dashboard from AJ Bell, over the next year the Footise is set to pay out a total of £87.5bn in dividends, which would provide a yield of 4.4%. If you buy when yields are high, you can lock in superior returns for the decades ahead.
What should you choose? Just the biggest current yields? I’d say no to that, for a couple of reasons. Firstly, we’ve seen plenty of previous high dividends which have become overstretched and ended up being slashed — think of the financial crisis, for example. And you need to be careful not to end up too heavily invested in one sector — the housebuilding business currently dominates the FTSE 100’s top dividends, and while I like the sector, I think diversification is a good idea.
Looking at FTSE 100 stocks offering decent yields, but with good cover by earnings (which suggests they’re reliable), and with a long-term record of progressive dividend rises, I’ve come up with a handful that I reckon could form the basis of a top retirement portfolio.
I’d go for something like BP or Royal Dutch Shell, with forecast yields of around 5% (which would have been higher had you bought them before the recent share price rises), SSE on close to 7% (with good visibility and adequate cover), BT Group, whose dividends have been growing and yielded 4.6% this year, Rio Tinto or BHP Billiton, which are cyclical but yield around 5%, and perhaps Legal & General on a yield of 5.7%
I’d add a housebuilder, probably Taylor Wimpey with a yield of 7.5% (though perhaps a bit toppy as earnings growth is slowing), and I might even add a couple of investment trusts. Want more? Read on…