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Have £2,000 to invest? I think a FTSE 100 tracker can be an investment for life

If you want to take advantage of your annual tax-free allowance by investing in a Stocks and Shares ISA, start here. Long-term investing in the stock market can be a better option than trying to build up your retirement savings by stuffing money into Cash ISAs. After all, most cash savings accounts, including ISAs, pay a low rate of interest, which won’t help you compound your savings enough to keep up with inflation.

Investing can be uncomplicated

But where do you begin? You may not have the hours in the day or the inclination to find out all about investing. And you don’t need to. Here’s why. I believe one of the simplest long-term investments you can make is to put money into a low-cost FTSE 100 index tracker fund held within a Stocks and Shares ISA. Then, just leave it alone – for decades if you can, and until you retire.

If you do that your investment will follow the fortunes of around 100 of the UK’s largest public limited companies, many of which trade with operations all over the world. In one blow, by investing in a tracker, you’ll have achieved instant diversification across companies and by trading geography.

Such diversification lessens your exposure to under-performing companies, but there’s a second layer of defence too. The index tends to be ‘self-cleaning.’ In other words, under-performing firms will likely drop out of the index over time to be replaced with more vibrant enterprises. I think that’s one reason why the FTSE 100 has always bounced back from its lows in the past.

Decent growth potential

But as well as bouncing back regularly, the index has grown too. The Footsie started on January 3 1984, at 1,000 yet, as I write, it stands close to 7,600. So over a period of around 35 years, it’s returned about 660%. To put that in perspective, if you’d invested £2,000 in the index when it started in 1984, your investment would now be worth around £15,200.

On top of that return, you would also have collected a regular stream of dividends from your FTSE 100 index tracker fund. Right now, for example, the dividend yield of the FTSE 100 stands above 4%.

But you can make your Footsie investment work even harder for you in the years to come by reinvesting that stream of dividends back into the index tracker fund. In that way, you’ll be on the road to compounding your gains, and compounding is key to building wealth because the returns tend to grow exponentially over time — that means the returns from the investment can get bigger and bigger.

It’s true that past performance is no guarantee of future returns, but I’m bullish on the outlook for the FTSE 100 for the next few decades. Meanwhile, one of the simplest ways of reinvesting your dividends is to choose an ‘accumulation’ version of a tracker fund, which automatically reinvests the dividends for you, such as the Legal & General UK 100 Index Trust – Accumulation. You can hold that fund in an ISA directly with Legal and General or via a broker such as Hargreaves Lansdown.

I think an FTSE 100 tracker is a great start and a decent investment for life.

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Kevin Godbold has no position in any share mentioned. The Motley Fool UK has recommended Hargreaves Lansdown. 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.