Living off a State Pension of £8,767 in retirement may prove challenging for many people. Certainly, it could help to pay for basic necessities in older age, and may go some way to providing financial freedom. However, a second income is likely to be required for most people during retirement.
With interest rates being low, assets such as cash and bonds may prove to be an unappealing means of generating a passive income. Similarly, the amount of capital required to undertake a buy-to-let may make it impractical for many investors.
However, with the FTSE 100 offering a dividend yield of 4.5%, it could be the most appealing means of generating a passive income. Its dividend growth potential, as well as the higher yields offered by some of its members, could mean it’s a worthwhile means of obtaining a greater degree of financial freedom in older age.
Relative appeal
As mentioned, the income returns on cash and bonds are low at present. It’s difficult to obtain a return of more than 1.5% on cash, for example, while bond prices have been pushed higher by continued low interest rates. This means they now offer relatively low yields.
Looking ahead, interest rates could move down before they increase. Inflation is below the Bank of England’s target of 2%, while the prospects for the UK economy continue to be uncertain. This may persuade the Bank of England’s Monetary Policy Committee to cut interest rates to stimulate the economy during a period of political uncertainty.
Although lower interest rates could make buy-to-let investing more popular, the amount of capital required and the unfavourable tax treatment of second homes means it may lack appeal from an income investing perspective.
Passive income potential
Although the FTSE 100 may currently have a 4.5% dividend yield, it’s possible to obtain a higher income return from buying a range of dividend shares. In fact, around a quarter of the index currently yields in excess of 5%. With the cost of sharedealing having fallen significantly in recent years, this means that it’s relatively cost-effective to buy a diverse range of stocks that together offer a much higher yield than other mainstream assets.
In addition, the FTSE 100 offers strong dividend growth potential. Its international focus means that it may benefit from a fast pace of growth in emerging markets. This could make its income return even more appealing over the coming years.
While there are risks ahead for the index that may cause its price level to fall, its relatively high dividend yield suggests that investors have factored them in. As such, using a portion of your capital to generate an income from FTSE 100 shares could be a sound move that helps to supplement a disappointing State Pension in retirement.