Many investors gravitate, in the end, to picking individual shares. And there’s a sound reason for that.
Cranking up annualised returns
We can expect, for example, annualised returns in the mid-to-high single-digit percentages from the general market averages, such as the FTSE 100 index. But the aim of investing is to compound your capital over time. And we know that small increases in the annual returns achieved multiply into vast differences in the eventual sum you’ll end up with after compounding for several years.
Individual shares have the potential to deliver higher annualised returns than the general market indices. Therefore, individual share-picking is the way to go for many. But I reckon picking shares only really makes sense when you can invest at least £1k into an individual name, and even that amount is close to being uneconomical when you consider the transaction costs you’ll face.
My own lower limit for an investment in any one stock is £2k. But using my rule of thumb, you’d only be able to spread your £5k investment between two names, and that would make for an uncomfortably concentrated portfolio. So, I wouldn’t do it.
Instead, I’d look for a share-backed fund that is supported by many individual shares, and my money would automatically be spread over all of them, thus providing instant and acceptable diversification.
Side-stepping fund manager risk
However, tempting though it might be to choose a managed fund, I’m wary. On the surface, it seems like a good idea to pick a fund managed by a team of seasoned investment professionals who will make all the underlying buy, sell, and hold decisions for you along the way. And there are some strong candidates out there, such as Mark Slater (who is also a talented illustrator, by the way), and Nick Train. But others such as Neil Woodford looked like a safe bet five years ago, and his funds have been a train-wreck.
It’s hard to pick a good fund manager and past performance isn’t a reliable guide, as Neil Woodford recently demonstrated so spectacularly. But the stakes are high because managed funds will charge you a hefty ongoing fee whether they perform well or poorly, and those costs will eat into your returns.
So, with my first £5k to invest I’d concentrate on building an investment base via low-cost, passive index tracker funds. Looking ahead, I’d want to participate in the London market. But I don’t know whether income or growth-focused strategies will work best in the years to come.
So, I’d invest in a tracker that follows the FTSE 100 index for income and one that follows the FTSE 250 index for a greater nod to growth potential. On top of that, I’d want to participate in the dynamic market in the US, so aim to track the S&P 500 index. £5k spread evenly across those three trackers strikes me as a potentially cracking place to start.
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Kevin Godbold has no position in any share 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.