With all the volatility in the financial markets last year, both growth and dividend stocks have lost a lot of favour with many investors. After all, it’s only natural to run for the hills after a double-digit stock market decline. And many are finding refuge in Cash ISAs and savings accounts.
It’s not hard to understand why. Unless the bank goes under, deposits are near risk-free and provide a steady stream of reliable income courtesy of interest. What’s more, even if the worst comes to pass and a bank fails, the first £85,000 of a depositor’s money is protected by the FSCS.
As the Bank of England hikes interest rates to combat inflation, the allure of savings accounts is getting stronger. And yet, moving all capital into one may actually be a bad move. Even with higher risk-free returns, savings accounts still have historically and continue to lag behind inflation. In other words, they may provide safety but they also dent wealth in terms of spending power.
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That’s why investing in top-notch dividend stocks from the FTSE 100 may be the smarter move.
Capitalising on a high market yield
As with every stock market correction, panicking investors have a habit of selling anything with a pulse out of fear. And this indiscriminatory emotionally-driven behaviour often results in terrific companies being put on the chopping block.
As frustrating as this is to watch, it does create potentially lucrative opportunities for income investors. As stock prices drop, dividend yields go up. And providing that cash flows remain uncompromised, these higher payouts are often sustainable.
Looking at the FTSE 100, its average dividend yield in 2021 stood at 3.2%. Following the aftermath of 2022, this now stands at 4.2%. And several dividend stocks within the UK’s flagship index offer considerably more.
According to The Times, as of September 2022, the average interest rate offered by savings accounts in the UK was 0.85%. By direct comparison, FTSE 100 dividend stocks offer more than four times that amount in dividends alone.
Building a £1m ISA with dividend stocks
Instead of putting £750 a month into savings, investors can place this money into a Stocks and Shares ISA instead. And using this capital, they can buy individual dividend stocks to capitalise on the high yields offered by high-quality enterprises today.
Alternatively, investors could simply buy shares in a FTSE 100 index fund to pursue a £1m ISA. Historically, the index has generated an annual return of around 7%, including dividends. And assuming it continues to deliver these returns, investors would have a seven-figure investment portfolio within 32 years.
As exciting as the prospect of becoming a millionaire for minimal effort sounds, it’s critical to remember that, unlike saving, investing has its risks. 2022 was a good reminder that the stock market doesn’t always go up. And once-thriving businesses can end up in the gutter if economic conditions change.
A poorly selected portfolio of dividend stocks may leave investors with considerably less than expected. That’s especially true if the underlying businesses later announce a dividend cut, or outright cancellation, as free cash flow suffers.
However, these traps can often be avoided by investing with due diligence. And given the potential rewards, investing is worth the risk, in my mind.
