People often think that you need lots of money to start investing, but you don’t. Here’s how you can get your cash working better for you with your own investment portfolio.
One of the misconceptions about investing is that it is somehow exclusive, and you need to have a significant sum of money to begin with. This is not the case. You can start investing with small regular amounts from as little as £25 per month.
Investing on a regular basis, such as monthly, suits many people's income streams. You can apply the same principle that you use with your company pension scheme, by committing a certain percentage of your salary every month.
Regular investing also helps create discipline. Making a commitment to set aside a small, affordable amount each month is unlikely to affect your lifestyle and will help you take control of your financial future.
While this approach suits the regular income of an employed person, it can be more challenging if you are self-employed, and you are paid on a more variable basis. If your cash flow means you cannot commit to a regular monthly contribution, then you could invest a small lump sum and add to your investments when you have spare cash available.
Investing regularly is a less risky approach, but even a lump sum can be invested over time rather than all at once.
I still want to invest a lump sum – how much is enough?
There’s no definitive answer as to how much is an appropriate amount to invest as a lump sum. Ultimately, everyone's circumstances and objectives are different. And all the usual investing rules about being diversified apply.
But there are certain things to consider that can help you decide. First is cost. Add up all the fees you will pay, including the platform fee, trading costs, stamp duty (if applicable) and, if you’re buying a fund or investment trust, the yearly charge.
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Now, subtract these fees from the sum of money you had planned to invest and decide whether the numbers make sense. For instance, a lump sum of £100 might mean your investment has to grow 10-15% before you’ve even covered your costs. This highlights the risk of investing too little. The more you invest, the more money goes towards buying the investment rather than on costs.
Remember, the long-term average annual rate of return for UK shares is 5% above inflation, although stock markets rise and fall over time rather than grow in a straight line. That’s why committing to regular contributions - especially as stock markets fall - is the key to generating wealth over a lifetime.
Objectives will influence your decision too. You might decide to put a small portion of your portfolio into speculative stocks. If you think a company might multiply in value many times, using smaller sums of money as part of a high risk, high reward strategy can work. Investing smaller sums into larger, safer but slower growing companies may struggle to generate returns high enough to make it worthwhile.
As interactive investor has a fixed fee charging structure, our costs do not increase as your investments grow in value.
Benefits of ‘pound-cost averaging’
One of the key benefits of investing regularly is what’s called pound-cost averaging. By investing each month, you benefit from times when stock markets are falling because you are able to buy more units in a fund or shares in a company.
For example, what if you decide to invest £200 each month into a fund? In January the price is £10 so you buy 20 fund units. Over the following two months the price has fallen to £9 so you are able to buy 22 units in February and March. By April the price has rallied and is up to £11 so you buy 18 units.
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This means you've bought 82 units with your £800 investment, which at £11 each, means your total investment is now worth £902.
Conversely, if you had invested the full £800 in January as a lump sum, you would have bought 80 units, which would now be worth £880. This is £22 less than if it had been drip fed into the fund.
This approach doesn't always work in your favour though. When markets are buoyant lump-sum investing usually wins out over a regular investing strategy.
However, it is difficult to predict stock market behaviour with any great accuracy and so time your investments precisely. By investing regularly, this decision is taken out of your hands. Over time, the averaging effect of regular investing reduces the risk of getting market timing wrong.
It also removes the risk that you put all your cash into the market just before a nasty dip.
Investing as early in your life as possible – which can be achieved by investing small amounts regularly – allows more time to benefit from the wonders of compounding.
In a nutshell, compound interest refers to the way investment returns themselves generate gains. For instance, if you invest £1,000 into a fund that increase in value by 5% over one year, you'll make £50. If you don't withdraw any money, the next year you'll earn 5% on £1,050, which is £52.50. This doesn't sound like much of an uplift, but as each year passes, the compounding effect multiplies.
The effect becomes even more powerful when you also reinvest dividends from companies you invest in. The new shares you buy with the dividend money then have the potential to grow in value and generate dividends themselves.
Investing regularly prevents poor decision making
Investing regularly takes the emotion out of investing, a behavioural flaw that can prove detrimental to returns. When stock markets fall it is natural to panic, but those that sell risk losing a lot of value, often in a short space of time. Regular investing allows investors to ‘keep calm and carry on’.
As history shows, for those willing to take a long-term perspective, sharp short-term stock market falls end up being a mere footnote in the grand scheme of things. Over time, stock markets recover. An adage that still has plenty of relevance today is that "time in the market, rather than timing the market" is one of the keys to investment success.
Funds for a first-time investor
Multi-asset funds are a sensible starting point. These funds split your money across a mix of different assets, but they mainly buy shares and bonds. Some may also have a small amount of exposure to property, as well as alternative assets, such as infrastructure and gold.
A mixture of assets will, in theory, perform differently from each other in different market conditions. This helps your portfolio grow and avoid large fluctuations in overall value when stock markets fall.
interactive investor has six Quick-start funds aimed at beginner investors to help make investing easy. Each fund invests in both shares and bonds. We offer a choice of three passively managed funds from Vanguard – these track the various asset classes with little intervention from a fund manager - and three actively managed funds from Columbia Threadneedle where a fund manager will make decisions on what to invest in and when.
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Well-diversified global funds and investment trusts are also potential good fits for beginner investors. One option is F&C Investment Trust (LSE:FCIT), one of interactive investor’s Super 60 investment ideas. The trust invests in more than 350 companies.
Review your fund choices and the amount you invest over time
While it is perfectly acceptable to stick with a well-diversified muti-asset fund, as your investments grow you might want to replicate the diversification by building your own portfolio.
Going down this route involves buying different types of funds, and spreading your money across different asset classes, regions, and investment styles.
As well as looking at how you manage your portfolio as it grows, also think about increasing the amount you pay in if your expenditure changes – such as if you receive a pay rise.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.