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With all the volatility in financial markets last year, both growth and dividend stocks have fallen out of favor with many investors. After all, it’s only natural to run for the hills after a double-digit stock market crash. And many are finding refuge in Cash ISAs and savings accounts.
It is not difficult to understand why. Unless the bank fails, deposits are nearly risk-free and provide a steady stream of reliable interest income. What’s more, even if the worst happens and a bank fails, the first £85,000 of a depositor’s money is protected by the FSCS.
As the Bank of England raises interest rates to combat inflation, the allure of savings accounts is only getting stronger. And yet, moving all the capital to just one can be a bad move. Even with higher risk-free returns, savings accounts have historically lagged and continue to lag inflation. In other words, they can provide security, but they also reduce wealth in terms of purchasing power.
That’s why investing in top-tier dividend stocks of the FTSE 100 it may be the smarter move.
Capitalizing on high market performance
As with every stock market correction, panicked investors have a habit of selling anything with a pulse out of fear. And this emotionally driven indiscriminate behavior often results in excellent companies being put on the chopping block.
As frustrating as this is to watch, it creates potentially lucrative opportunities for income investors. As stock prices fall, dividend yields increase. And as long as cash flows are not compromised, these higher payments are often sustainable.
As for the FTSE 100, its average dividend yield in 2021 stood at 3.2%. Following the aftermath of 2022, it now stands at 4.2%. And several dividend stocks within the flagship UK index offer considerably more.
According to The times, as of September 2022, the average interest rate offered by savings accounts in the United Kingdom was 0.85%. In direct comparison, FTSE 100 dividend stocks offer more than four times that amount in dividends alone.
Creating a £1M ISA with Dividend Shares
Instead of saving £750 a month, investors can put this money into a stocks and shares ISA. And using this capital, they can buy individual dividend stocks to capitalize on the high returns that high-quality companies offer today.
Alternatively, investors could simply buy shares in a FTSE 100 index fund to look for a £1 million ISA. Historically, the index has generated an annual return of around 7%, including dividends. And assuming it continues to generate these returns, investors would have a seven-figure investment portfolio in 32 years.
As exciting as the prospect of becoming a millionaire with minimal effort sounds, it’s critical to remember that, unlike saving, investing comes with risks. 2022 was a good reminder that the stock market doesn’t always go up. And once thriving businesses may end up in the ditch if economic conditions change.
A poorly selected portfolio of dividend stocks can leave investors with far less than expected. That’s especially true if the underlying businesses later announce a dividend cut, or a full cancellation, as free cash flow takes a hit.
However, these pitfalls can often be avoided by investing with due diligence. And given the potential rewards, it’s worth the investment in my opinion.
