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Forget buy-to-let! Here’s how I’d aim to make a million from the FTSE 250

Buy-to-let investments have been a popular means of generating a rising income and capital growth in recent decades. With house prices moving higher and demand for rental properties buoyant, buy-to-lets have enhanced the wealth of a large number of landlords over a sustained period of time.

Now, though, the appeal of FTSE 250 stocks could mean they offer a better opportunity than buy-to-let to make a million. With low valuations, high growth potential and diversification benefits, many people may be better off pivoting from buy-to-let to the FTSE 250.

Valuations

With UK house prices becoming increasingly unaffordable since the financial crisis, it seems unlikely they can continue to rise significantly over the coming years. In fact, the house-price-to-earnings ratio stands at close to its highest-ever level, only having been higher for a brief time during the credit crunch.

Although a house price fall similar to that reported in 2007-2009 may not be ahead, the housing market may experience a period of slower growth relative to other mainstream assets.

By contrast, the FTSE 250 seems to offer excellent value for money at present. It has a dividend yield of 3.2%, which is relatively high for the index. This suggests it offers a wide margin of safety, with investors potentially able to build a portfolio of stocks that trade at discounts to their intrinsic values.

Growth prospects

As mentioned, the outlook for UK house prices continues to be uncertain. Although the same could be said for the FTSE 250 as a result of its focus on the UK economy, the index includes the shares of a wide range of companies that operate across a variety of sectors.

This may mean it’s better insulated from any potential Brexit-related fallout, and could experience a more resilient performance over the long run.

Furthermore, the FTSE 250 has international exposure. While this may only act as a mild counterweight against a possible downturn in the UK economy, it nevertheless offers greater geographical diversification than a portfolio of buy-to-let investments in the UK.

Risks

Holding a small number of properties within a portfolio may provide a degree of risk reduction for a landlord. However, in reality, one tenant failing to pay rent could cause significant cash flow challenges for a buy-to-let investor.

A landlord is likely to require a large number of properties within their portfolio in order to significantly reduce the risk of rent not being collected on a property.

By contrast, an investor can easily buy a range of FTSE 250 stocks in order to reduce company-specific risk. While market risk will remain, over the long term the index has generated an annualised total return of around 9%.

As such, while volatility may remain high, returns from investing in the FTSE 250 could be impressive. The index may, therefore, be a better means of making a million than undertaking a buy-to-let.

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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.