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How I’d beat the State Pension with FTSE 100 dividend shares

Peter Stephens
Hand holding pound notes

The performance of the FTSE 100 over the last 20 years has been disappointing. It has risen from around 6,700 points to trade at approximately 7,300 points. That’s a rise of just 9% in 20 years.

As a result, many investors may feel that the index lacks capital growth potential. However, this may not be the case, since it now appears to have a wide margin of safety, improving growth prospects and a solid track record of growth since its inception in 1984.

Furthermore, it offers a high dividend yield that could make it appealing for investors who are looking for a passive income to overcome a low State Pension. Therefore, the index could be worth investing in for growth and income investors alike.

Growth potential

As mentioned, the FTSE 100’s performance since inception has been strong. It has gained 6,300 points in nearly 36 years. This works out as an annualised growth rate of 5.7%. When dividends are added to that figure, its total annual returns are around 9%.

Given that its returns since inception include the rather disappointing performance of the last two decades, where it has gained just 600 points, its performance from inception in 1984 to the end of the 1990s was exceptionally strong.

The cyclicality of the index, as well as its valuation, suggest that it could now enter a period of strong gains that are more akin to its performance soon after inception in 1984, rather than that of the last two decades.

For example, many of its members have low valuations. In addition, the index’s dividend yield of 4.5% is significantly above its long-term average. Therefore, while there are risks facing the world economy at the present time, such as a trade war between the US and China, the growth potential of the index seems to be high.

Income potential

As well as offering the chance to generate a sizeable net egg for retirement due to its growth potential, the FTSE 100 also offers income opportunities. Its income return is high compared to other mainstream assets such as cash and bonds that offer negative real returns in many cases.

Furthermore, the dividend growth potential offered by many FTSE 100 companies appears to be high. They could produce strong growth due to their international exposure, with emerging economies expected to be the main drivers of global GDP growth over the coming years.

Certainly, FTSE 100 shares can fall in value. This may mean there is short-term volatility. However, by diversifying across a range of companies that trade in a variety of sectors and geographies it may be possible to reduce overall risk. This could produce an improving income outlook for retirees that helps them to overcome what continues to be a relatively disappointing State Pension. In turn, this may lead to a higher degree of financial freedom in older age.

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Peter Stephens has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Motley Fool UK 2019