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With an average dividend yield of 3.2%, is the FTSE 100 such a great place for investors looking for passive income to look? I think it is.
While it’s true there are bonds – and even savings accounts – that offer higher yields, there’s much more to UK stocks than this. And this is something investors should take note of.
Headline returns
UK government bonds currently offer some pretty eye-catching returns. The 30-year gilt comes with a yield of 4.38% and the coupon on the 2-year note is 3.75%.
Compare that with the FTSE 100’s 3.2% dividend yield and it becomes hard to see why passive investors should even look at the stock market. Especially as stocks are naturally riskier than bonds.
The chances of a company not paying a dividend are much higher than the UK government not paying its debts. So if the yields are lower on stocks, what’s the point of even looking?
This, however, misses an important point. Dividend shares come with opportunities that bonds don’t, but investors need to look past the headline yield to see this.
Growth opportunities
The big risk with gilts is inflation. The amount someone gets back from a bond is fixed in nominal terms so if the value of cash goes down, so does the value of the return.
This isn’t the case with stocks. And this is especially true with companies that retain some of the cash they generate and reinvest it for future growth as well as paying dividends.
Businesses that do this are – if things go well – in a position to make more money in future and return more cash to shareholders. Over time, this can be a huge advantage over bonds.
Even stocks with low dividend yields can be excellent examples of this. Over time, their ability to grow can make them extremely valuable sources of passive income.
Stocks to consider buying
One stock I’m looking at buying right now is Bunzl (LSE:BNZL). The stock is down 35% since the start of the year and comes with a 3.44% dividend yield as a result.
That’s not huge considering how much the stock has fallen, but I’m excited about where the company can go from here. Importantly, it’s committed to using £700m a year for acquisitions.
This approach can be risky – if the firm overpays for a business, it can result in wasting cash that could have been used more profitably. And that probably makes it riskier than a bond.
Importantly, though, Bunzl operates in a highly fragmented market. And that means it should be able to find opportunities even if some aren’t available at attractive prices.
Stocks vs bonds
I think Bunzl’s strategy could generate the kind of growth that can more than offset the effects of inflation. And if I’m right, it could well be a better investment than a 30-year bond.
It’s also not the FTSE 100’s only worthy candidate, either – not by a long shot. There are a few other stocks that are worth looking at for investors trying to earn passive income.
They might not have the most eye-catching yields. But from a long-term perspective, what matters isn’t what the stock will return tomorrow, but what it will return over 30 years.
