When it comes to investing more modest amounts of money, people can often be flippant. Financial websites will usually talk about investing tens of thousands of pounds. But for a novice investor, sums like these are probably unimaginable.
Someone with £500 might think of taking a punt on a crypto-currency, or an out-of-favour stock like Sirius Minerals. If it goes wrong, it’s not going to be devastating, is it? And if it goes right? Well, the rewards could be enormous.
I think this is unwise.
Don’t lose money
If the golden rule of investing is to not lose money, then this must apply to any amount of cash.
£500, if invested properly, could grow into a nice chunk given some time. It’s for this reason that I believe a prudent investor should use the same level of due-diligence whether they are investing a couple of hundred pounds or a couple of thousand.
At this point, people might bring up risk and reward. If they stand to lose only a couple of hundred pounds, then the investor isn’t taking much risk. I’d disagree: the risk here is losing money, regardless of the amount.
Warren Buffett sums it up nicely when he says “buy a stock the way you would buy a house”. He doesn’t add that, for small amounts, purchase them the way you would buy a shed. No investment should be taken lightly.
Investors should also be cautious of the commissions and fees being levied on their transactions. For example, if they were to purchase a single stock, this could incur around a £10 fee. So with a £500 investment, they are already 2% down before their holding period starts. That’s without looking at the platform fees that some ISAs and pensions charge.
The other problem with investing lower sums of money is diversification. By purchasing a single share, it’s impossible to build up a diversified portfolio. Diversification will hopefully mitigate losses against the portfolio if a particular sector is performing badly.
Fear not, I think it’s still possible even with a modest sum to build a diversified portfolio and not incur large fees.
I believe that index funds could be the solution. These types of funds aim to track a certain market’s performance. As this will contain holdings in all of a given market’s components, it offers instant diversification to an investor.
Some funds offer differing allocations to worldwide index funds. For example, with £500 an investor could open a Vanguard LifeStrategy fund, in which they can choose how much of the portfolio they wish to hold in equities, with the rest held in bonds. In this fund, the equity portion of the portfolio is internationally diversified, tracking many indices throughout the world, including the UK.
The other benefit of an index tracker is the usual low fee structure. For example, the Vanguard LifeStrategy fund I mentioned has a 0.22% ongoing charge.
Although £500 may not sound like an awful lot of money, investors should remain cautious. It all adds up in the long-term.
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T Sligo has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.