The FTSE 100’s recent market crash may understandably push some investors to consider assets that could offer lower risks.
Assets such as the Cash ISA offer the potential for steady returns with no volatility. However, with interest rates expected to remain low over the medium term, the return on a Cash ISA could prove to be disappointing.
As such, buying FTSE 100 shares could be a sound move. These stocks offer the potential for significant capital gains and income over the long run.
Cash ISA drawbacks
The biggest drawback of opening a Cash ISA is its fixed return. Today, the best flexible Cash ISA interest rate on the market is just 1.19%. That rate may not even cover inflation over the long term. On the other hand, most FTSE 100 dividend stocks tend to increase their payouts every year.
Unfortunately, it doesn’t look as if this trend will be repeated in 2020. Many FTSE 100 dividend stocks have already cut their dividend payouts to preserve cash and strengthen their balance sheets.
As such, buying FTSE 100 shares today may seem like a risky move. It could be some time before these companies reinstate their shareholder distributions. Meanwhile, opening a Cash ISA provides an immediate, if modest, passive income.
However, the index’s track record shows a recovery is very likely. It may take some time, but evidence shows that over a span of 10 years or so, the FTSE 100 always produces positive returns. The average annual return over the past three-and-a-half decades is around 7%.
This suggests investors who buy a basket of FTSE 100 stocks at present are likely to experience strong total returns in the coming years. These strong returns may also come with shape declines, but long-term investors should be well rewarded.
The reinvestment of dividends
A large proportion of the index’s past total returns have been derived from the reinvestment of dividends. So, if you’re looking to outperform the Cash ISA over the long run, dividend stocks are the way to go.
Nevertheless, as mentioned above, a range of FTSE 100 companies have cut their dividends over the past few weeks. This suggests the best way to capitalise on the power of dividends over the long run is to buy a basket of dividend stocks. This could increase the potential for attractive long-term returns while reducing risk at the same time.
Now could be the perfect opportunity to build a strategy based around the reinvestment of dividends. Many income shares are currently trading at exceptionally low valuations. Some blue-chip stocks even offer dividend yields of nearly 10%. That makes the level of income on offer from the market’s top Cash ISA look rather insulting.
With this being the case, buying FTSE 100 dividend stocks today could be an excellent way to build your financial nest egg. You could even replicate the tax benefits of a Cash ISA by using a Stocks and Shares ISA.
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Rupert Hargreaves 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.