One of the biggest challenges when seeking to make a million is knowing how much risk to take. This in itself can determine the route an individual seeks to take to seven-figure status, with slim-chance options such as The National Lottery nonetheless offering the potential for high returns in a short space of time, but also being high-risk as the chance that you will lose your money is huge.
In contrast, a low-risk option such as a Cash ISA may mean the risk of loss is minimal. It does, however, also mean that the chance of generating a return that is high enough to make a million is exceptionally low.
As such, finding a path between those two options could prove to be a sound idea. With that in mind, here’s how the stock market could offer an attractive balance between risk and reward over the long run.
Systematic risk
When investing in shares, there are two types of risk to which an investor is exposed. The first is company-specific risk. This is where there is a chance of losing money from an event that causes a company’s share price to decline. This may be a profit warning or declining investor sentiment, for example.
Through diversification it is possible to remove almost all company-specific risk. This leaves systematic risk, which is the potential for the wider stock market to experience a decline that leads to a loss for the investor.
Systematic risk cannot be diversified away, since it is a risk that is inherent with investing in shares. However, a glance at the chart of the FTSE 100 or FTSE 250 shows that while bear markets are fairly common, so too are bull markets. In fact, every bear market has been followed by a bull market, and vice-versa. This means that even if an investor experiences a loss, that is likely to be only temporary in nature – as long as they have sufficient diversity within their portfolio.
Growth potential
While the stock market currently faces an uncertain period, now could prove to be an opportune moment to invest in a variety of shares. The FTSE 100 and FTSE 250 have relatively high yields, and have fallen from their record highs achieved last year. This suggests that they could generate impressive long-term growth, and that investors may be able to obtain margins of safety at the present time.
Certainly, there may be volatility ahead, and systematic risk could increase if, for example, further tariffs are placed on imports by the US and China, or the latter’s economic growth rate continues to deteriorate. However, in many cases those risks may already be priced in by investors.
Compared to the 1.5% annual return on offer from a Cash ISA and the one in 45 million chance of winning The National Lottery, the 9% total annual return of the FTSE 250 over the last two decades has significant appeal. From a long-term perspective, it could be the worthwhile middle ground required in order to realistically make a million.
