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£200 a month to invest? I’d forget gold and use a Stocks and Shares ISA

Gold has been an outstanding investment over the last year, climbing by around 20% to more than $1,550 per ounce. That compares to an increase of around 4% for the FTSE 100 and of 12% for the FTSE 250.

The yellow metal has been a star performer over longer periods too. Over the last five years, gold has climbed nearly 35%, compared to less than 10% for the FTSE 100 and about 24% for the FTSE 250.

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Based on the figures I’ve given above, you might think that the case for gold is pretty watertight. However, I think there are a number of good reasons why stock market investments are still likely to outperform gold in the real world. In this article I’ll explain why I’m sticking with stocks.

Consistency is key

The stock market has a reputation for boom and bust returns. Crashes certainly do happen. But history suggests that UK stocks deliver much more stable returns than gold, which can be very inconsistent.

For example, the gold price in August 2003 was unchanged from April 1990. Over the same period, the FTSE 100 rose by nearly 85%.

Between 2003 and 2011, gold then exploded upwards, rising from $315 per ounce to an all-time high of just over $1,900 per ounce. Unfortunately the price of gold price then crashed, falling by 45% to $1,060 in less than five years.

Anyone who bought gold between June 2011 and March 2013 is probably still sitting on a loss. If the price of gold continues to rise, these investors may finally break even, after nearly 10 years.

But holding on to losing investments and deciding whether to keep investing over long periods is very difficult. Many people find it too hard and end up selling at a loss, missing out on any future recovery.

Cash income beats gold

In my experience, it’s much easier to hold on to an investment that’s showing a loss if it provides a regular income. Gold pays no income, but the FTSE 100 currently offers a dividend yield of around 4.4%. That provides an attractive income for index fund investors.

The FTSE 250 dividend yield is a more modest 3.2%, but historically, this has been offset by stronger growth.

There’s a second benefit to all of this income too.

If we include dividends in our measure of returns, then the FTSE 100 has delivered a total gain of 32.3% over the last five years, matching gold.

Investors in the mid-cap FTSE 250 index have done even better. They’ve enjoyed a total return of 48.9% over the last five years, smashing gold’s 32% return.

Where I’d invest today

If you’ve got £200 per month to invest, I believe the stock market still offers the best opportunities. If I was starting today, I’d open a tax-free Stocks and Shares ISA. I’d then invest in FTSE 100 and FTSE 250 index funds, paying £100 per month into each.

In my view, this approach should provide a good balance between the faster growth of the FTSE 250, and the stability and more generous income provided by the FTSE 100.

My sums suggest that if you buy ‘accumulation units’ so that your dividends are reinvested automatically into your funds, saving £200 per month could leave you with a fund worth £117,800 in 20 years. I reckon that that could provide a useful boost to your retirement plans.

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Roland Head 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.