Some investors overlook the value of UK dividend stocks, as they go chasing whizzy growth stocks, or get distracted by passing fads and frenzies. Last year’s dividend bloodbath, when scores of FTSE 100 companies cut shareholder payouts, didn’t help.
Yet I think UK dividend stocks are a great way to generate the income I need to enjoy a comfortable retirement. The FTSE 100 is still on course to yield 3.8% this year, according to AJ Bell, and that should rise over time as more companies restore payouts. I plan to invest all my dividends for growth while I’m still working, then draw them as income when I retire.
Here’s why income is so important to the FTSE 100
Too many investors underestimate the power of UK dividends stocks. FTSE 100 shares offer some of the most generous dividend income in the world, far higher than the US, where the S&P 500 currently yields just 1.45%. Over time, I expect them to make up the bulk of my returns.
Over the 20 years to 31 December 2019, the FTSE 100 rose around 600 points to 7,542, a rise of just 8.8%. With dividends reinvested, the total return was a far more impressive 122%, according to Schroders. Dividends rule!
Under something called the 4% rule, I’d need an investment pot of £500,000 to generate income of £20,000 a year. The rule suggests that if I withdraw 4% of my portfolio each year as income, my capital will never run out.
I’d consider buying these UK dividend stocks
One downside is that £20,000 a year may not be worth as much in real terms when I retire, depending on what inflation does in the interim. However, I’d have my basic State Pension on top of that, which adds £9,339 a year in today’s money. That brings my income closer to £30,000. I might need to save even more, but what’s the alternative? Cash no longer cuts it.
Reaching £500,000 is a tall order. It involves saving £150 a month, every month, over a 45-year working lifetime (and increasing this sum by 3% each year). This assumes annual growth of 5%. If my portfolio generates 7%, I could get there by saving £100 a month. It helps that the government offers tax relief on contributions, reducing the real cost to me.
I’d start by targeting the best UK dividend stocks, many of which generate income of 5%, or more, with share price growth on top. Insurer Aviva yields 6.5%. Telecoms giant Vodafone Group yields 5.99%. Pharmaceutical giant GlaxoSmithKline (5.92%), utility National Grid (5.37%) and mining giant Rio Tinto (5.33%) also offer great levels of income.
Best of all, UK dividend stocks aim to increase shareholder payouts, year after year. That should give me a rising passive income, over time. Dividends aren’t guaranteed, of course. As we saw last year, they could be reduced, or scrapped altogether.
That’s why I’d hold a balanced blend of top UK dividend stocks, so if some underperform, others should compensate by doing better than I expected.