When it comes to deciding what to do with your excess capital, considering risk and reward is imperative. After all, many people are likely to feel that a lack of high potential rewards is unappealing, while significant risks may also be unattractive.
As such, the FTSE 250 could offer a worthwhile destination for your spare capital. While the National Lottery and Premium Bonds may offer the potential for high rewards, they each have risks in terms of losses and low average returns, respectively.
Although the FTSE 250 also carries a risk of loss, its return potential has historically been high. As such, from a risk/reward perspective it appears to be a highly attractive means of making a million.
While the performance of the FTSE 250 may have disappointed in recent years, over the long run it has offered significant returns for investors. For example, over the last two decades, its total returns have been around 9% per annum.
Certainly, it is possible to gain a higher reward from holding Premium Bonds. However, for most holders, the annual return is around 1.4%. That’s a similar rate of return to a Cash ISA, with it being behind inflation.
Similarly, although the National Lottery may provide the opportunity to win significant sums of money, the reality is that the vast majority of people do not gain from buying lottery tickets. With the odds of winning the National Lottery being one in 45m, investing in FTSE 250 stocks is more likely to make you a millionaire.
Risk of loss
While the National Lottery carries a risk of capital loss, the capital value of your Premium Bonds will not fall due to them being backed by the government. However, when inflation is factored in, there is the potential for them to lose value in real terms. As such, Premium Bonds carry a risk of a loss of spending power – especially when held over the long run.
By contrast, FTSE 250 shares are likely to significantly outperform inflation over the long run. While they carry a risk of capital loss, this can be reduced through holding a range of companies in order to limit the impact on a portfolio of poor share price performance across individual stocks.
While the National Lottery and Premium Bonds may be appealing from a tax perspective, with winnings on them not being taxed, shares are also not subject to tax when held within a Stocks and Shares ISA.
Since it is possible to invest up to £20,000 in a Stocks and Shares ISA per year, it is likely that most investors will be able to gain their desired exposure to the stock market solely through an ISA. As a result, they may not pay any tax on the dividends and capital gains generated on their shares.
The FTSE 250 has historically offered a higher return than Premium Bonds and the National Lottery for the vast majority of people. With it being possible to reduce risk through diversification and cut taxes through having a Stocks and Shares ISA, buying a range of mid-cap shares appears to be a better means of making a million than the National Lottery or Premium Bonds.
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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.