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FTSE 100 Index Benchmark funds have gained popularity in recent years. These simple investment funds passively mimic the performance of the Footsie while offering a secondary income in the form of dividends.
Alternatively, there are “accumulation” versions where all dividends are reinvested in the fund. This would involve giving up income today to obtain a potentially higher return in the future.
Here, I'll take a look at how much you could expect to receive in dividends from a £20,000 investment in an income-distributing FTSE 100 tracker fund.
Needles and haystacks
Firstly, I can clearly see the appeal of this style of investment. I get broad exposure to multiple companies (in this case, the 100 largest publicly traded companies in the UK) through a single investment.
Plus, because index funds basically run on their own, they typically cost very little (especially compared to active funds). High fees can significantly reduce long-term returns.
John Bogle, the pioneer of passive investing, captured the simplicity of index funds in this timeless quote: “Don't look for the needle in the haystack, buy the haystack..”
Entry
So how much could the haystack pay me? Right now, the dividend yield on FTSE 100 stocks is 3.6%.
But that doesn't mean you'd get exactly that return, because dividends aren't guaranteed. Companies can reduce or cancel their payouts to shareholders, while others increase them.
For example, the luxury firm Burberry just eliminated its dividend as it grapples with falling sales. Vodafone should be cut in half, while Aviva (LSE:AV.) increased its payout by 7.7% last year.
Also, stock prices fluctuate a lot, which affects returns due to their inverse relationship, so there is quite a bit at stake.
However, as things stand, the FTSE 100 yield is the aforementioned 3.6%, which is broadly what I would expect from an index tracker. This means I expect to receive around £720 a year in dividends on a £20,000 investment.
Please note that I have ignored platform fees and funding costs here.
Forget about the haystack
Is that any good? Well, it's better than a bag of crisps in your face, as my uncle likes to say. But I think I can get better results by buying individual shares in the FTSE 100 index.
Returning to Aviva, its shares yield 6.5%, which is not far from double the FTSE 100 average.
Better still, City analysts believe the insurer will increase its payouts in the coming 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 – a huge difference!
One risk I would highlight with regard to Aviva is its concentration in the UK and Ireland markets, which could limit growth in the future, as these are quite mature markets.
However, the company is in very good financial shape. In March, its Solvency II capital ratio was a healthy 206%. And it is buying back £300m of its shares, while its private healthcare business is booming with NHS waiting lists near record highs.
I would still be reluctant to invest £20,000 in a single stock in case the dividend was cut. But there are more than 30 FTSE 100 stocks currently yielding more than 3.6% (some much more). So I don't need to buy a tracker, as you can build up a nice basket by picking individual stocks.