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Forget a FTSE 100 tracker fund. Here’s how I’m investing my ISA money in 2020

Regular readers will know that I’m not a big fan of FTSE 100 tracker funds. Given the index’s significant exposure to companies with low growth prospects, and its lack of exposure to smaller companies and the technology sector, I think there are much better ways to invest than simply buying a FTSE 100 index fund. 

Want to know how I’m investing my ISA money in 2020? Here’s a look at my investment strategy.

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Dividend stocks for passive income

Around 60% of my ISA money is invested in roughly 20 dividend stocks (mainly from the FTSE 100 but also from the FTSE 250). The aim of this part of my portfolio is to build up an ever-increasing tax-free passive income stream that I should be able to eventually retire on, while also providing an element of portfolio stability.

My focus here is on high-quality businesses that are likely to enjoy tailwinds from long-term trends (such as the rise of wealth in the emerging markets) and have the potential to outperform the FTSE 100 over the long run. The companies I have invested in generally sport a healthy yield, a decent dividend growth track record, solid revenue growth, a high level of profitability (return on equity), and a strong balance sheet.

Top holdings in this part of my portfolio currently include the likes of Diageo, Unilever, Prudential, DS Smith and Legal & General.

Growth stocks for capital gains

The remaining 40% of my ISA capital is focused on growth stocks. Here, the aim is to generate capital gains, which can be reinvested into the dividend section of my portfolio over time, generating more dividends. 

I invest in growth stocks in a few different ways. Firstly, I own a mini-portfolio of around 10-15 UK growth stocks which I believe have strong long-term growth prospects. These range from FTSE 100 companies down to micro-cap companies. When picking stocks for this part of my portfolio, I look for strong revenue and earnings growth, a high return on equity, and a solid balance sheet.

Companies that I own here include Rightmove, Softcat, Keywords Studios, Boohoo and GB Group. All of these stocks have delivered brilliant long-term returns for investors in the past and I expect them to generate further gains in the future, given time.

Secondly, I invest in growth-focused global funds to get exposure to high-growth companies listed internationally such as Apple, Microsoft and PayPal. Given the growth that these kinds of technology companies are generating, I believe that it’s essential to have portfolio exposure.

Some of the funds I own in this regard include Fundsmith Equity, Lindsell Train Global Equity and the Polar Capital Global Technology fund. All of these funds have brilliant long-term track records and provide exposure to world-class companies listed overseas.

Overall, I believe that this strategy has the potential to deliver the winning combination of capital growth and passive income, while outperforming the FTSE 100 over the long run. It’s more work than owning a FTSE 100 tracker, but I think the extra work is likely to be worth it over time.

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Edward Sheldon owns shares in Diageo, Unilever, Prudential, DS Smith, Legal & General, Rightmove, Softcat, Keywords Studios, GB Group, Boohoo, Apple, and Microsoft and has positions in the Fundsmith Equity fund, the Lindsell Train Global Equity fund and the Polar Capital Global Technology fund. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool UK owns shares of and has recommended Apple, Microsoft, PayPal Holdings, and Unilever. The Motley Fool UK has recommended boohoo group, Diageo, DS Smith, Keywords Studios, Prudential, Rightmove, and Softcat and recommends the following options: long January 2021 $85 calls on Microsoft, short January 2020 $97 calls on PayPal Holdings, and short January 2021 $115 calls on Microsoft. 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.