The Motley Fool

Forget a Cash ISA! I’d do one of these two things today

You’ll have read plenty of articles in recent years urging you to forget cash and invest in the stock market. You’ll have read how interest rates are rubbish, and how stocks have delivered higher long-term returns. And you’ll have read plenty of tips for individual stocks.

In this article, I’m going to look at a theoretical investor — let’s call her Jodie — who this time last year had £8,000 saved and fancied the idea of getting into stocks. She was a little cautious, so she put £4,000 into a Cash ISA at an interest rate of 1.25% and £4,000 into a Stocks & Shares ISA. Her plan was to buy four stocks and expand her portfolio in subsequent years as she gained experience.

Starter stocks

On 1 August last year, she invested £1,000 in each of the four stocks below.

  Sector Share price No. of shares Forecast dividend yield
Centrica Utility 149p 671 8.1%
BT Telecoms 232p 431 6.6%
Marks & Spencer Retailer 285p 351 6.6%
Lloyds Bank 64p 1,563 5.0%

She stuck to blue-chip FTSE 100 companies and bought in different sectors. She’d read this is a good approach for new investors. She’d also read plausible commentaries on why each of these stocks could be a good investment.

Dividends

A year on, Jodie has received the 1.25% interest of £50 on her Cash ISA. Meanwhile, her Stocks & Shares ISA has delivered dividends of £245 (6.125% yield). It’s a little less than she had hoped, due to M&S cutting its final dividend, but she’s very happy. Looking ahead to the next 12 months, with M&S’s dividend rebasing fully kicking in, and Centrica also having announced a rebasing, she calculates the total dividend from the four stocks will be £191 (4.775% yield). It’s a little disappointing, but still much superior to interest on cash.

Capital values

Jodie’s more disappointed when she looks at the capital value of her stocks. The standing of her portfolio at 31 July is summarised in the table below.

  Current share price 1-year performance Current value Dividends Total
Centrica 76p -49% £510 £81 £591
BT 193p -17% £832 £65 £897
M&S 208p -27% £730 £50 £780
Lloyds 53p -17% £828 £49 £877
Total £2,900 £245 £3,145

Her experience illustrates what can happen when you’re building a portfolio. Her four picks proved unfortunate, but were not altogether implausible in a period when half the stocks in the FTSE 100 delivered a negative performance, with well over a third declining by double-digits.

For new investors like Jodie, even one big early setback like Centrica can be disheartening. She’ll have to deal with it. She’ll also probably be finding picking her next four stocks quite stressful. She could pick winners, of course. The thing to do is keep calm, keep learning and keep investing.

Alternative

If you don’t like the sound of picking individual stocks, the good news is that you can still enjoy the long-term fruits of the stock market. You can invest in all the companies in the FTSE 100 via a simple ‘tracker’ fund, such as the iShares FTSE 100 UCITS ETF.

If Jodie had bought this tracker instead of her four stocks, she’d have got 528 shares at 758p a share. The share price declined 1% to 750p over the 12 months, reducing the £4,000 capital value to £3,960. However, dividends of £171 (4.275% yield) upped the total value to £4,131.

She’ll still have falls in her capital value in the market’s down phases. However, by definition, a market tracker won’t drop anywhere near as far as many individual stocks, making it easier to keep calm and carry on investing.

You Really Could Make A Million

Of course, picking the right shares and the strategy to be successful in the stock market isn't easy. But you can get ahead of the herd by reading the Motley Fool's FREE guide, "10 Steps To Making A Million In The Market".

The Motley Fool's experts show how a seven-figure-sum stock portfolio is within the reach of many ordinary investors in this straightforward step-by-step guide. Simply click here for your free copy.

G A Chester has no position in any of the shares mentioned. The Motley Fool UK has recommended 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.