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Here’s why the FTSE 100 could beat bonds as an investment

With the FTSE 100 having fallen by as much as 11% since its all-time high in May, the decade-long bull market could be nearing its end. As a result, some investors may believe that the potential for further volatility and share price falls makes other assets, such as bonds, more appealing. While that may be the case in the short run, the reality is that in the long term, the FTSE 100 may provide a superior risk/reward opportunity.

Volatility

While bonds are generally less volatile than shares, some stocks can offer greater stability than many investors realise. Certainly, the FTSE 100 itself has been extremely volatile in recent weeks, declining significantly from its record high. However, some of its constituents could offer less volatility than the wider index, due to their lower correlation with the wider economy.

For example, shares in the tobacco, healthcare and utility sectors may provide defensive appeal. They rely on consumer confidence to a lower extent than many of their more cyclical peers. And this could mean that they offer more resilient earnings growth potential. With many defensive shares having been out of favour in recent years, due to investors focusing on cyclical shares with high potential growth rates, defensive shares could offer good value for money.

Income

Although bonds can provide an appealing level of income over a long-term period, shares may be able to better them in many cases. The FTSE 100 yields 4% at the present time, but a number of its constituents offer much higher yields. This could mean they provide higher income returns than bonds – especially at a time when bond yields are relatively low, as a result of a long period of rock-bottom interest rates.

Certainly, the income from shares may be less reliable than it is from bonds. But if an investor is able to select companies with substantial headroom when making dividend payments, as well as improving cash flow, this may lower the risk of dividends not being paid. As such, through buying stable companies with track records of dividend growth, it may be possible to generate a much higher income return than bonds would be able to offer.

Growth potential

While the FTSE 100 may be experiencing a challenging period at the present time, this isn’t anything new. Stock markets have always been volatile, and investor sentiment has been fickle throughout history. Therefore, the panic-buying of perceived safer assets may be a worthwhile move in the short run, but in the long run, it can lead to underperformance when it comes to capital growth.

Given that a number of high-quality shares now trade on lower valuations, there could be a buying opportunity present for long-term investors. While falling share prices may be a cause of concern in the short run, they provide the chance to buy now, and reap the potential rewards over the long term.  

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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.