With the FTSE 100 offering a dividend yield of around 4.5% at the present time, its income return dwarfs that of a cash ISA. In fact, the UK’s main index offers an income return that is three times that of a cash ISA, which suggests that it may be worth focusing on over a long timescale.
Certainly, the index comes with greater risk than a cash ISA. But for investors who are able to hold a variety of shares over a sustained period of time, it could have a positive impact on their overall wealth.
Time period
For investors who have a long-term investing horizon, it appears to make sense to invest in the stock market rather than a cash ISA. The main reason for this is that the risk/reward ratio could be significantly more appealing.
Certainly, there is a risk of loss from shares which cash savings do not carry. There have been a number of major financial crises in the last couple of decades that have led to significant losses for some investors. However, for those investors who have been able to hold their stocks over the long run, the index has always rebounded to post higher highs.
For example, while it declined to around 3,600 points during the last major bear market in 2009, it has since more than doubled. And while it has dropped since reaching its highest-ever level in May 2018, in the long run it is likely to post new record highs based on its track record of having done so.
For investors with less time, shares may not be a worthwhile risk. There may not be time for a turnaround to be delivered. But over the long run, the 4.5% income return of the FTSE 100 versus the 1.5% from a cash ISA could have a substantial impact on total return.
Diversification
While there is always the risk of a widespread fall in share prices, investors also face company-specific risk. This is where a company experiences a challenging period, with its share price declining and leading to a loss for investors.
In order to reduce this risk, investors may wish to opt for a diverse range of shares. This will help to reduce company-specific risk, thereby limiting the risk of a portfolio. It also means that if a company reduces its dividend due to financial difficulties, for example, it will have a smaller overall impact on their income level.
Since managing a portfolio online is now relatively straightforward, and the cost of trading shares is very low, building a diverse range of income shares is an achievable goal for a variety of investors. This means that smaller investors may have a realistic alternative to a cash ISA that, in the long run, is able to deliver a higher return that boosts their financial prospects.