On the surface, the FTSE 100 has proven to be quite resilient to the ongoing macroeconomic climate. After all, the index is up more than 7% over the last 12 months.
However, a closer inspection reveals that not every constituent has been so fortunate. Many continue to trade at a discount while the underlying businesses strive to recover and adapt to a higher interest rate environment.
That presents an interesting opportunity for patient investors. And in my mind, the potential rewards far outweigh the gains being offered by even high-interest savings accounts right now. In fact, given enough time, capitalising on undervalued shares today could pave the way to building a seven-figure portfolio in the long run. Here’s how.
Saving vs investing
Putting money into a savings account is by no means a bad financial decision. This in itself is a form of investment that’s highly liquid and exceptionally safe. Even if a bank were to go under, deposits of up to £85,000 are insured by the FSCS.
Such protections don’t exist in the stock market. And as this year’s volatility has perfectly demonstrated, the level of risk is significantly higher. However, this comes with the benefit of potentially explosive returns.
Throughout history, shares have been one of the best asset classes to grow wealth. And while the journey is rarely a straight line, smart stock pickers can unlock double-digit annual returns. And those who prefer index funds can still achieve respectable gains that exceed even what the best savings accounts offer today. Of course, savings accounts still play a vital role.
Since shares are unpredictable in the short term, a golden rule of investing is to never buy shares using money that’s needed in the next three to five years. This type of cash belongs in an interest-bearing savings account. But any unneeded excess income is likely better served being put to work in the financial markets.
Becoming a stock market millionaire
Since its inception, the FTSE 100 has delivered an average annual return of around 8%. That’s already ahead of the current 6.7% inflation rate, enabling wealth generation in real terms. Assuming this performance continues throughout the future, investing just £500 a month for the next 34 years would push a brand-new portfolio into seven-figure territory.
This timeline can even be accelerated by being more selective. Hand-picking a collection of top-notch stocks at sensible prices today could boost a portfolio’s average return. Even if it just delivers an extra 2%, that’s enough to cut five years off the waiting time.
Needless to say, these sorts of gains could unlock a far more luxurious lifestyle. But as exciting as this prospect might be, there is the caveat of risk. As recent market conditions have demonstrated, stock prices don’t always go up. And even the UK’s largest corporations can be sent into a tailspin.
Corrections and crashes are a natural and largely unavoidable part of an investment journey. And three decades is more than enough time for multiple periods of extreme volatility to emerge. Depending on the timing of these events, an investor may have considerably less than expected.
Nevertheless, the potential returns from investing in shares in the long run make it a risk worth taking, in my mind.
