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As the state pension age steadily increases, creating a passive income to support my retirement becomes more important every day.
I am looking to generate my retirement income by investing in a portfolio of UK stocks, mainly FTSE 100 dividend shares. The blue-chip stocks listed in the index offer some of the highest shareholder payouts in the world, with the best returns between 5 and 9% per year.
I’m buying high yield stocks
If I could generate a passive income of £20,000 a year, on top of the £10,000 state pension, I would retire on £30,000, which is about the current average salary.
However, in practice, you would be much better off than the average worker. By then my kids should be out of the house and my mortgage will be history. At that age I won’t have to make more pension contributions or pay for life insurance either.
Better still, my passive income of £20,000 will be free of all income tax, as long as I invest within my annual allocation of Stocks and Shares ISA.
In retirement, I plan to follow something called the 4% rule. This states that if you earn 4% of your investment portfolio as income each year, your pot will never run out. To generate £20,000 a year, you would need a portfolio of £500,000.
This takes time to build of course. A lifetime of work, to be precise. If I invested £250 a month and increased it by 3% per year to keep up with inflation, it would take me 30 years to reach my goal. Assuming an average total return of 7% per year on my portfolio, I would have accumulated £416,096 in that time.
If you started by investing £500 a month, you could do it in just 22 years, at which point you would have £403,545. But the closer I am to retirement, the more money I will have to invest each month to reach my goal. And vice versa.
Some FTSE 100 favorites
I think now is a good time to buy the top FTSE 100 dividend stocks as many offer high yields at affordable valuations.
packing group worlds, for example, returns 4.76 per year, but trades at only 11.6 times earnings (a figure of 15 is considered fair value). Insurer fan it yields more than 6.41% and is even cheaper at the current valuation of 10.5 times earnings.
Builder Barratt developments it produces an impressive 7.81% and is trading at a low of 5.7 times earnings. At 10.71%, miner red river it offers the highest yield on the market, but is one of the cheapest stocks of all, trading at 5.6 times earnings.
Dividend income is never guaranteed, shareholder payments can be reduced at any time. These stocks seem cheap, but they all have challenges in different ways. Since I plan to invest for decades, they have plenty of time to outperform them.
In total, I’d like to build a portfolio of around 10-15 stocks to spread my risk in case one or two underperform. If I am successful, I will be free to stop working at a time of my choosing.
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