The recent volatility in the FTSE 100 may mean that many investors seek to reduce risk within their portfolios. In doing so, they may be attracted to defensive assets such as Cash ISAs and gold. After all, there is no risk of capital loss from a Cash ISA, while gold has historically been a store of wealth during challenging economic periods.
However, rather than seeking to reduce risk, the recent pullback in the FTSE 100 could be an opportunity to buy high-quality companies at relatively low prices. In the long run, this could produce higher returns, since the risk/reward ratio may be further in an investor’s favour.
Historic returns
While the FTSE 100 has experienced multiple bear markets since its inception in January 1984, its overall trajectory has been upwards over the long run. In fact, it has increased over seven-fold since starting life at 1,000 points.
As such, the fact that the index has recently experienced a period of volatility that has resulted in a lower price level is a relatively common occurrence. Likewise, a bear market at some point over the coming years is somewhat inevitable, with the track record of the index suggesting it is merely a matter of time before it occurs.
Risk
While the natural response from any investor to market volatility is to buy defensive assets in order to reduce risk, history shows that such a time can be the perfect moment to buy more shares.
This may sound counterintuitive, since there may be a higher risk of loss in the short term. But for long-term investors who are able to hold their stocks through the ups and downs that the stock market experiences, buying while companies are priced at lower levels could increase their overall returns.
While there may be paper losses in the short run, buying during the dotcom bubble and financial crisis, for example, could have led to an investor achieving wide margins of safety across a variety of holdings.
Returns
Although gold and Cash ISAs may produce higher returns than a falling stock market in the short run, their long-term prospects appear to be more limited.
In the case of Cash ISAs, interest rate rises are forecast to be low over the coming years. This may mean that the returns on a Cash ISA continue to lag inflation over the medium term.
Although gold has become increasingly popular in the last couple of decades, it is highly dependent on investor sentiment. As such, if the world economy produces strong growth as it is expected to do over the long run, a portfolio of high-quality shares may outperform the gold price. Stocks also offer an income return, unlike gold, which could mean that the inevitable rise in global interest rates over the long run causes sentiment towards gold to decline.
Takeaway
Although buying shares during volatile periods for the stock market may seem counterintuitive to many investors, doing so could allow you to obtain more favourable risk/reward ratios. As such, now could be a good time to focus on the FTSE 100, rather than on Cash ISAs and gold, in order to increase your chances of making a million.
