The FTSE 100’s dividend yield currently stands at around 4.5%. This is relatively high compared to its historic average, and suggests the index is undervalued.
Not only could this mean there are opportunities for investors to buy high-quality shares while they trade on low valuations, they may be able to obtain a significantly higher income return than other assets, such as a Cash ISA.
In fact, with interest rates expected to remain low over the coming years, it could be the case that savers record negative real-terms returns, while the FTSE 100 delivers impressive total returns over the long run.
Income opportunities
At present time, the best income return available on a Cash ISA is around 1.5%. Although this is around a third of the FTSE 100’s income return, it’s possible to obtain an even higher level of income through buying individual large-cap shares. In fact, around a quarter of the FTSE 100’s members yield over 5% at the present time. This could allow an investor to generate a portfolio income return of over 5%, or even 6%, over the long run.
Dividend growth could make the FTSE 100 an even more appealing place to invest in order to generate an improving income return. The FTSE 100’s international focus means that it could benefit from the growth opportunities in emerging markets, while the prospects for interest rate rises in the UK seem to be limited. With inflation being higher than the returns on Cash ISAs, their income potential seems to be rather disappointing.
Capital returns
While Cash ISAs lack capital growth potential, the FTSE 100 could generate high returns for investors. As mentioned, the index seems to be undervalued after its decade-long bull market. Indeed, the index trades only slightly higher than it did 20 years ago. One reason for this is that it was overvalued after trading close to 7,000 points in 1999. Another reason is that investor sentiment is currently weak as a result of uncertainties facing the world economy.
Clearly, there could be a challenging period ahead for economies such as the US and China. Political risks and an ongoing trade war may hold back their growth prospects and lead investors to adopt cautious attitudes towards risk. However, it appears as though a significant part of the uncertainty they face is priced in to the valuations of FTSE 100 stocks, thereby providing a buying opportunity for long-term investors.
As such, now could be the right time to invest in a diverse range of FTSE 100 companies. The index offers a favourable income return, as well as wide scope to deliver capital growth over the long run. Even though it has higher risk than a Cash ISA, its return potential suggests that it’s a more worthwhile opportunity from a risk/reward perspective.