If you’ve got £1,000 to invest and no more, for the time being, that money is precious.
In fact, it’s more precious than you might realise. For example, it dawned on well-known, super-successful investor Warren Buffett early in his life that every dollar he owned was actually worth all of the future dollars he would go on to compound the money into.
So, if he lost a dollar, he was really losing tens and hundreds of dollars in the future. And if you lose your £1,000, you are really losing what could become a vast chunk of your future retirement savings, perhaps.
Minimising the downside risks
Therefore, if I only had £1,000 to invest right now, I’d invest it with particular care and by focusing first on downside risks. To me, that means out the window with individual shares altogether. I reckon there’s too much single-company risk attached to owning individual stock market names, even big ones. Check out the history of well-known shares such as Lloyds Banking Group, Persimmon and Thomas Cook for evidence of the risks involved.
I think it’s better to diversify across several shares so that any one company’s bad performance can’t drag your total overall investment down too far. But you can’t really do that with £1,000 because the execution costs, such as trading fees and tax, will eat up too large a part of your investment.
To overcome the diversification problem, you could invest in a fund run by a manager who chooses the underlying investments. But the ongoing fees can be high, which will eat into your returns. And as a group, there’s plenty of evidence that fund managers often fail to beat the general performance of the stock market. So you could end up paying high fees to actually underperform the market with your investment.
Keeping up with the market, compounding gains
I used to think that choosing your fund manager carefully could lead to market-beating returns, but that idea was blown out of the water for me with the recent Neil Woodford debacle. He was a well-respected and successful fund manager with a knack for outperforming the market, which he did for many years. But since setting up his own investment management firm a little while back, his luck appears to have run out and his funds have lagged well behind the market.
So I’d chuck the idea of investing in managed funds out the window too. Instead, I’d put my £1,000 into a passive, low-cost tracker fund that aims to replicate the performance of the general market. There are many you can choose from, but I reckon a good place to begin is with a tracker fund that follows the fortunes of the FTSE 100 index of the UK’s largest public limited companies.
If you go for the ‘accumulation’ version of the tracker fund you choose instead of the ‘income’ version, it will automatically reinvest the dividends for you, which would set you on the road to compounding your money.
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Kevin Godbold has no position in any share 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.