It’s tempting to think that you need a large windfall to make any difference to your financial situation.
Tempting, but wrong.
Relatively modest amounts can make a big difference over time. As I’ll explain, £500 used wisely today could leave you much better off in a few years’ time.
Here are three things I’d suggest doing with £500 today, in order of priority.
1. Repay expensive debt
If you’ve got credit card or other high interest debt, repaying this should be a top priority. This is because the interest payments on this kind of debt can be cripplingly expensive.
For example, if you owe £500 on a credit card with a 20% APR, you’ll be charged interest of £100 every year. Owe £2,000, and you’ll be paying £400 per year in interest.
If you let interest pile up on your credit card, it will gradually suck up more and more of your spare cash.
Start at the top: As a general rule, you should repay debt in order of interest rate, starting with the highest rate.
If you haven’t got any high-cost debt, then great! Perhaps you could pay £500 off your mortgage, assuming your lender allows this. Every overpayment will reduce your future interest costs and bring forward the day you’ll be mortgage free.
2. Do you have a rainy day fund?
Life has a way of throwing nasty surprises at us. Whether it’s an unexpected loss of income or a costly car breakdown, they can be pretty stressful. Having some cash set aside for a rainy day can make things a lot easier.
Before investing any cash, I’d strongly suggest aiming to set aside three to six months’ income in an easy access savings account.
3. Start investing!
If you’ve cleared any expensive debt and put some cash aside for a rainy day, then the next thing I’d do with £500 today is to start investing.
With Brexit on the horizon and gloomy news headlines all around, you may be worried about whether now is the right time to put cash into the stock market.
We can’t predict the short-term future, but in general I believe it’s best to get started as soon as possible. History suggests that over the long term (five to 10 years), the stock market usually goes up.
However, I don’t think £500 is enough to buy individual stocks. Dealing costs will eat into your money, even if you only invest in one company — something I’d never do, as I think it’s too risky.
What I would do instead is to open a Stocks and Shares ISA and start investing in a low-cost FTSE 100 tracker fund. The FTSE 100 offers a dividend yield of about 4.3% at the moment, so in addition to any capital gains, the value of your investment will be boosted by regular income.
According to Barclays, the long-term average annual return from the stock market is about 8%. On this basis, £500 invested today could be worth more than £1,000 in 10 years’ time.
Tracker funds have very low costs and allow monthly investments from as little as £25, so a £500 lump sum is plenty to get started. You can then add further lump sums when possible, or set up a monthly payment by direct debit.
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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Barclays. 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.