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Have £1,000 to invest? Why I’d go for this investment held in a Stocks and Shares ISA

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Stocks and Shares ISAs are great! Everything you invest in one is tax-free, which means no capital gains tax, or income tax when you eventually draw the money out, no matter how much it has grown.

You can put as much as £20,000 in one every year, which can be spread between cash interest-earning accounts or investments on the stock market, such as shares and funds. You can even participate in a Help-To-Buy ISA and a Lifetime ISA and make those part of your overall £20,000 allowance, which is a good idea because the government will add an extra 25% to your investment on at least one of them if you have both. Yes, that’s free money, so why wouldn’t you if you fit the age and circumstantial requirements?

Tax-free compounding

But if I had £1,000 to invest right now, I’d want to invest in an FTSE 100 tracker fund that automatically reinvests the dividends back into the fund. Of course, I’d hold that investment within a Stocks and Shares ISA to take full advantage of the tax-free benefits when my fund grows and compounds, as I would expect it to.

I think the FTSE 100 is an attractive investment right now. If you look at a price chart for the index over, say, the past 20 years, you’ll notice that it’s always rebounded from its lows. So the lows end up looking just like dips that correct upwards again. There’s a good reason for that. The FTSE 100 has a high weighting of cyclical businesses in its ranks, such as oil companies BP and Shell, miners such as BHP Billiton and Rio Tinto, and banks such as Barclays and Lloyds. And the thing that cycles with the cyclical businesses is their profits and share prices, which is what keeps the index wiggling up and down.

That shouts to me that it’s almost always a good idea to buy the dips of the FTSE 100, and you have probably noticed that the index is down from its highs right now. But you can iron out those ups and downs by dripping money into your tracker fund in stages. A monthly payment would be ideal, and it would mean you’d get more for your money when the index is down and you won’t be putting all your money into the market when it is riding high.

Over the long haul, I think you’ll do well because all the time those dividends will be ploughing themselves back into your investment and the reinvested dividends will earn a share of new dividends and so on – that’s compounding, and some people call it magic. I call it arithmetic, and I think it has the potential to make you rich if you stick at it.

Great upside potential

But it gets better. Between 1984 and 1994, the Footsie increased just over 228%, and some people think another period of outperformance like that could be just around the corner. That theory makes sense to me after the long period of economic recovery we’ve seen following last decade’s credit-crunch. But even if it doesn’t happen, compounding will likely drive your investment higher over time and it will all be done with a passive, low-cost tracker fund with minimal effort on your part. Ideal!

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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has recommended Barclays and Lloyds Banking Group. 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.