Finding capital to invest in UK shares is often the main challenge investors face, especially for individuals without a reliable income stream. But every once in a while, a small windfall comes along, whether it be an inheritance from a relative or a refund on a large discretionary purchase.
Providing there aren’t any more immediate bills that need taking care of, investing this lump of capital could be a prudent financial move in establishing a retirement nest egg. So if an investor were to receive an unexpected £1,000, what should be done?
Putting the money to work
Even with the Bank of England hiking interest rates to combat inflation, the interest received on savings accounts is still pretty negligible. Even the best savings accounts still lag inflation. Therefore, simply depositing the money is actually destroying wealth.
Alternatively, the £1,000 can be invested into the stock market. The dividend yields of many established industry leaders drastically outperform what a savings account can hope to offer. And with the added bonus of capital gains from rising share prices, invested capital could lead to considerably higher returns.
Let me demonstrate. The UK stock market has historically provided investors with an average 8% annual return. Assuming it continues to deliver this rate of return over the next 10 years, a £1,000 lump sum would be worth around £2,220. By comparison, a 2% savings account would offer a mere £1,221 – 45% less.
Understanding the risk
While UK shares offer a far more attractive return, there is a giant caveat to consider. Savings accounts are pretty much risk-free. Even if the bank suddenly fails tomorrow, the FSCS protects up to £85,000 of an individual’s savings.
This level of protection does not exist in the stock market. And as 2022 has reminded everyone, shares don’t always go up. It’s important to remember that when buying a stock, investors are purchasing a small piece of a business. And should that business underperform, or become disrupted by a competitor, any investments in it will be adversely impacted.
That’s why before committing any capital, it’s paramount to know the nooks and crannies of the target enterprise. That includes understanding management’s long-term strategy, financial health, threats, and how it can beat its competitors.
Diversifying with UK shares
Even after executing expert-grade research, an investment can still go south. A frustrating reality of the stock market is that even the best companies can be derailed by an external factor. Just look at what happened to the leading travel stocks in 2020. Even the industry titans were brought to their knees as Covid-19 decimated the sector.
That’s why diversification plays a critical role in any investment portfolio. By owning a broad collection of high-quality companies across numerous industries and geographies, the impact of one failing can be mitigated by the others.
Sadly, diversification cannot eliminate all the risks of investing in UK shares. But it is capable of wiping out a considerable chunk. And thanks to financial instruments like index funds, even investors with just £1,000 can build a highly diversified portfolio.
