When it comes to deciding what to do with your hard-earned cash, focusing on risks and rewards could be a worthwhile move.
Certainly, the National Lottery offers high potential rewards. But the risk of ending up with nothing is high, since the odds of winning the top prize are one in 45m.
Premium Bonds, meanwhile, have no risk attached to them since they are backed by the government. But with an annual prize rate of 1.4%, the reality is that their returns are similar to cash.
As such, the FTSE 100 could offer a superior risk/reward opportunity. Through diversifying among different stocks, focusing on the long term and capitalising on changing investor sentiment, it may be possible to boost your financial future.
Diversification
One means of reducing overall risk when buying FTSE 100 shares is to diversify. It reduces the impact of one stock on the wider portfolio, which could limit the effect of a profit warning or poor financial performance from a specific company.
Diversifying is easier than ever due to the reduced cost of buying shares. In fact, it is possible to pay as little as £1.50 for regular investing services. This, alongside the falling costs of tracker funds, means that owning a range of businesses is within any investor’s grasp. With the world economy facing an uncertain period, diversification may become increasingly important in order to avoid businesses that experience a challenging financial period over the near term.
Long-term opportunities
Of course, the long-term prospects for the FTSE 100 continue to be highly attractive. The index has a solid track record of delivering total returns of around 8% per annum. As such, simply buying and holding a variety of shares could lead to returns that easily outstrip those of other assets.
Furthermore, it may be possible for an investor to use the ebbs and flows of the FTSE 100’s price level to boost their returns. In other words, the stock market is naturally cyclical. This presents an opportunity to buy while other investors are cautious, and to sell when they are optimistic. This strategy could enable an investor to ‘buy low’ and ‘sell high’ in order to maximise their returns over the long term.
Clearly, such a strategy can lead to short-term paper losses. The stock market regularly experiences corrections and bear markets that can cause disappointing returns at times. However, by focusing on the quality of a company and its valuation compared to its price, it may be possible to capitalise on more favourable risk/return ratios.
Investing today
Now could prove to be a worthwhile moment to purchase FTSE 100 shares. In many cases, weak investor sentiment has caused them to trade on valuations that are lower than their historic averages. Given the track record of the index, a long-term recovery that leads to significant returns for investors could be ahead over the coming years.
More reading
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- Stop saving, start buying dividend stocks: a simple plan to retire early
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Peter Stephens has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may 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 2019
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