Having dropped by over 1,000 points since May, the FTSE 100 now has a dividend yield which is approaching 4.5%. This is three times higher than the best cash ISA rate currently available. As a result, from an income perspective, the index appears to offer significantly greater appeal – especially since it equates to a positive real-terms return.
However, the FTSE 100’s dividend yield does not paint the full picture. There are currently 20 shares in the index which have a dividend yield of 6% or more. Buying a range of them could therefore create a dividend portfolio which offers an income return which is four or even five times higher than that offered by a cash ISA.
Low return
The impact of generating an income return which is that many times higher than a cash ISA could prove to be significant. Over the course of a decade, a cash ISA’s current level of return would lead to a 16% compounded return. In other words, an investment of £1,000 today would be worth £1,160 in 10 years.
While this assumes that interest rates for a cash ISA will continue to be 1.5%, the likelihood is that interest rates will move higher over the coming years. However, given the uncertain outlook for the UK economy, their pace of growth may be slow. The end result could be that even if a cash ISA gradually offers an increasing interest rate, its total return after a decade may prove to be less than inflation during the period.
Higher return
In contrast, a 6% dividend yield equates to a total income return of 79% over a decade. This would mean that £1,000 invested in a range of shares which together deliver an average yield of 6% would be worth £1,790 in 10 years. However, the amount could be significantly more than that. Over a 10-year period, many companies would be expected to increase dividends. This could have a major impact upon an investor’s income return, and mean that it grows at a faster pace than inflation.
Alongside this, there is scope for capital growth. While in the short run there is always the potential for paper losses to be felt, over a 10-year period there is an increasing chance that a range of FTSE 100 shares will be able to deliver rising market valuations. As such, a 6% income return may prove to be just one part of an improving total return.
Risk/reward
Clearly, some individuals may feel that a cash ISA’s perceived lower risk versus shares makes it more appealing. While this may be true during periods where share prices are falling, the reality is that when inflation is factored in, a cash ISA is currently set to record negative returns.
For investors who have a long-term view, a range of FTSE 100 shares could be a better investment strategy. With the FTSE 100 currently offering a large number of stocks with high yields, now could be the right time to buy.
