FTSE100 Index funds have become increasingly popular in recent years. These simple mutual funds passively mimic the performance of the Footsie while also paying out a second income in the form of dividends.
Alternatively, there are also accumulating variants where all dividends are reinvested in the fund. This would mean that you forego income today and potentially achieve a higher return in the future.
Here I will look at what dividends I could expect if I invested £20,000 in an income paying FTSE 100 tracker fund.
Needles and haystacks
Firstly, I can see the appeal of this type of investing. A single investment gives me broad exposure to several companies – in this case, the top 100 companies listed in the UK.
Because index funds are essentially self-managed, their costs are generally very low (especially compared to active funds). However, high fees can significantly reduce long-term returns.
John Bogle, the pioneer of passive investing, summed up the simplicity of index funds in this timeless quote: “Don’t look for a needle in a haystack. Just buy the haystack.”
The income
So how much could the haystack earn me? The current dividend yield for FTSE 100 shares is 3.6%.
But that doesn’t mean I’d get that exact return, because dividends aren’t guaranteed. Companies can cut or eliminate their payouts to shareholders, while others can increase them.
For example, luxury company Burberry has just canceled its dividend as it struggles with falling sales. Vodafone is to halve its number, while Aviva (LSE: AV.) increased its dividend by 7.7% last year.
Plus, stock prices fluctuate a lot, which impacts returns because of their inverse relationship, so there’s quite a lot going on.
However, the FTSE 100 currently yields the aforementioned 3.6%, which is broadly in line with what I would expect from a tracker. This means that if I invested £20,000, I could expect dividends of around £720 per year.
Note that I have ignored platform fees and fund costs here.
Forget the haystack
Is that good? Well, it’s better than a wet bag of chips in the face, as my uncle likes to say. But I think I’m much better off buying individual FTSE 100 shares.
Back to Aviva: This stock yields 6.5%, which is not far from double the FTSE 100 average.
Even better, City analysts expect the insurer to increase its payouts over the next few years. If those forecasts prove correct, the yield will rise to 7.2% in 2024 and 7.8% in 2025.
That would equate to payments of £1,440 and £1,560 respectively. What a huge difference!
One risk I would highlight with Aviva is its focus on the UK and Ireland markets. This could limit future growth as these are quite mature markets.
Still, the company is in strong financial shape. In March, its Solvency II capital ratio was a healthy 206 percent. It is also buying back £300 million of its own shares while its private healthcare business is booming and NHS waiting lists are reaching record highs.
That said, I would be reluctant to invest £20,000 in a stock if the dividend was cut, but there are over 30 FTSE 100 stocks currently yielding over 3.6% (some even more), so I don’t really need to buy a tracker as you can build a nice basket by picking individual stocks.
The post “If I invest £20,000 in a FTSE 100 tracker fund, I’ll get this as a second income” appeared first on The Motley Fool UK.
Further reading
Ben McPoland holds positions in Aviva Plc. The Motley Fool UK has recommended Burberry Group Plc and Vodafone Group Public. The views expressed on companies mentioned in this article are those of the author and may therefore 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 2024
