If you’ve got a large lump sum of money to invest, it’s not always easy to know how to start. There’s always the fear that you’ll make a wrong decision and end up losing it all.
In this article, I’ll look at two stock market strategies I think are relatively safe ways to start investing.
Can you spare the cash?
Let’s start with a couple of safety checks.
Do you have any high-cost debt, such as credit cards or store cards? If you do, it usually makes sense to pay these off first. Otherwise any gains you make on your investments will probably be wiped out by high interest payments.
Secondly, do you expect to need the money in less than five years? If so, I’d avoid the stock market. If you invest for short periods, you run the risk of being forced to sell during a market crash.
How I’d invest £20k in stocks
Investing in the stock market doesn’t come with any guarantees. You can lose money. But according to research by Barclays, the UK stock market has consistently delivered bigger gains than cash or bonds over the last 100 years.
If you’d like to invest in stocks, the first thing I’d do is open a Stocks and Shares ISA. These tax-free accounts allow you to invest up to £20,000 each year.
Option #1: Buy the market
The simplest way to invest in the stock market is to put money into an index fund, also known as a tracker fund. In the UK, FTSE 100 index funds are the most popular choice. These low-cost funds track the returns of the FTSE 100 – the 100 largest companies listed on the London Stock Exchange.
At the time of writing, the FTSE 100 offers a dividend yield of about 4.4%. That’s double the 2% interest available today from the best fixed rate cash ISAs. In addition, the index has the potential to deliver capital gains over time.
Option #2: Go direct
If you’d prefer to invest in individual stocks, then this is what I’d do.
I prefer to only own stocks which pay dividends, as I think they’re a good indicator of cash generation and management discipline. They also provide a regular stream of cash you can withdraw for income or reinvest in additional shares.
To get started you’ll need a list of stocks in the FTSE 100 and FTSE 250, including dividend yields and earnings forecasts. As a rule of thumb, I’d choose 15 to 20 stocks, covering all the main sectors of the market. For example, I’d probably want to own a bank or a large insurance company, a supermarket, an oil stock, a pharmaceutical firm, a utility, and so on.
I’d aim to pick stocks with a dividend yield of 4% to 6% and rising earnings forecasts. You may need to be a bit flexible on this. But in my experience, these simple criteria help to rule out companies that look too expensive or have obvious problems.
What happens next?
You can invest gradually, over 6 to twelve months, or all at once. There are pros and cons to both approaches, as no one knows what the market will do over the short term.
Once you’re fully invested, then the hard part starts.
To get the best results, you’ll probably need to sit tight and do nothing for at least five years, preferably longer.
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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Barclays. 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.