Although the State Pension is welcome in retirement, on its own it’s likely to be insufficient to provide a worthwhile income. It amounts to just £164.35 per week which, on its own, may not allow individuals to enjoy financial freedom in older age.
Of course, investors may also consider the FTSE 100 to be an inadequate means of planning for retirement. The index has risen in recent weeks, but continues to trade only slightly higher than it did almost 20 years ago. As such, it could be argued that there are other assets with stronger track records.
However, based on its current valuation, the FTSE 100 could enjoy a strong performance in the long run. The last two decades may have been disappointing, but it may deliver impressive total returns in future.
Valuation
While the FTSE 100 may only be a few hundred points higher than the level at which it traded in 1999, its valuation is much more appealing today. Twenty years ago, the index was flying high as a result of the dot com bubble. Investors were incredibly optimistic about the impact the internet would have on a variety of industries. It was expected to be a revolution which, potentially in the space of just a few years, would forever change the way that business was done.
Clearly, that didn’t come to fruition, or at least it took many more years to do so. Today, investors are much more cautious than they were 20 years ago, concerned about the risks posed by a slowing China, a rising US interest rate, and poor trading relationships between a variety of world economic powers.
As such, the FTSE 100 has a dividend yield of around 4.4%. In the last 20 years, it has rarely been higher. In fact, the times where it has been higher have occurred during major financial crises, when the prospect of dividends being paid by the index’s constituents has been called into question.
Growth potential
As well as having a low valuation relative to its historic level, the FTSE 100 also appears to offer significant growth potential. Since the majority of its income is derived from international markets, it has exposure to some of the fastest-growing markets in the world. Countries such as China and India, for example, are expected to offer strong GDP growth over the coming years, and this could create opportunities in a number of industries, such as banking and consumer goods.
Therefore, while the index faces potential risks, it could also be catalysed by the growth potential which the world economy offers. Clearly, volatility is likely to be high – as it always has been. But after a disappointing two decades, the future returns on offer from the UK’s main index could be surprisingly high. As such, it may prove to be a sound means to overcome the disappointing State Pension.