If you are looking to put small amounts of money to work each month by buying individual stocks and shares in an ISA, I am going to caution against doing that for now.
ISAs shield your investments from tax on interest, dividends, and capital gains. However, there is usually a small percentage fee for the account, and a fixed dealing charge when you buy and sell investments, which could be as high as £10.
A £10 charge per deal is a big issue if you are buying £50, £100, or £200 worth of stock a month because you lose 20%, 10%, and 5% to fees. A £50 stock investment will be worth just £40 and needs to return 25% before you break even.
A rule of thumb is that investing in the stock of 20 to 30 companies involved in different businesses will achieve an acceptable level of diversification for a portfolio. Some stocks do better than others over time, smoothing out the returns of a diversified portfolio.
Buying a single stock each month means it will take years to lower the risk of your portfolio through diversification. Investing small amounts in stocks means fixed dealing charges will take big chunks of your investment. So what can you do?
For someone with small sums of money to invest each month, I recommend putting that money in an ETF that tracks the FTSE 250. The FTSE 250 has tended to return more than the FTSE 100 over the last five years and has almost identical volatility.
The FTSE 250 is more diverse compared than the FTSE 100. Ten companies account for about 11% of the FTSE 250, while the top five companies in the FTSE 100 account for 26% of the index.
ISA providers typically charge you far less to deal in ETFs, some charge you nothing. You can build up your investment in a FTSE 250 tracker month by month without losing large chunks of your money to fixed fees, and you get the diversification you need from the start.
Over time, you will have built up a good-sized position in the FTSE 250. You may also be able to increase the amount you can invest each month. You can now consider investing in individual stocks. In terms of individual stocks, I would suggest looking for FTSE 100 stocks with good dividend yields to add to the FTSE 250 ETF already held in the portfolio. It’s a good idea to keep some funds in your FTSE 250 tracker to keep your portfolio diversified.
Good examples include Taylor Wimpey, which my colleague Royston Wild reported on recently, or Unilever, which is a consistent dividend payer.
Investing £50 a month in a single stock is unwise, but a £200 investment needs a 5.26% gain to get you back where you started, and a £300 investment needs just 3.5%. A stock with a dividend yield of 5% could have you breaking even in less than a year.
I think a minimum investment of £200 in a single dividend-paying stock is sensible. If you don’t have that amount to invest each month, then set aside £50 in a savings account for four months. This will save you something like £30 in dealing charges, which is a return in itself.
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James J. McCombie has owns shares in Unilever. The Motley Fool UK owns shares of and has recommended Unilever. 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.