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I think this could be the best way to invest £1,000!

When it comes to building a diversified portfolio, you might think a sum of £1,000 is inadequate. How can you buy multiple stocks without a large chunk of it going to fees?

I’m of the opposite mind. I think this amount is the perfect starting point to create a strong and varied base, and I’ll show how it can be done while minimising fees.

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Picking stocks can mean you have to pay large transaction fees, possibly eroding any return on investment. This is problematic for investors with smaller sums available to them.

For example, investing in individual stocks through a Stocks and Shares ISA will usually incur a fee of roughly £10 per transaction. If you buy 10 stocks for £100 each, and pay a £10 fee to buy each one, 10% of your initial investment will be lost. Additionally, the ISA provider may charge a platform fee. This might be based on a percentage of your overall investment in the ISA.

An investment in 20 or more different companies tends to be an acceptable level of diversification for most investors. This is very much a personal choice, with some people backing only several companies they believe will provide them with a satisfactory return, and others choosing more.

Logic does suggest that a portfolio built around various businesses across different trades and revenues emanating from diverse places should level out any bumps if one company should falter.

Tax matters

I think it is always sensible to max out your ISA allowance each year, if possible, because you can shield your investment from tax on capital gains and dividends in a Stocks and Shares ISA. 

The good news is that £1,000 can create a diversified portfolio and be shielded from tax.

I think the best way to do this is to buy an index fund that tracks the FTSE 100. By doing this, you are buying a portion of the UK’s top 100 listed companies. If you have a regular sum of money to invest each month – say, £100 – it would be a great idea to set up a regular, monthly payment. This will lessen the impact of market volatility by pound-cost averaging.

The FTSE 100 is geographically well-diversified. Much of the index’s revenues come from overseas territories.

Index funds tend to attract lower fees, often below 0.5%, charged on top of the ISA’s platform fee. Proportionately, an investment in index funds should lead to less erosion from transaction costs than owning individual shares. An arrangement of this type might work better for an investor with a smaller starting fund. 

In time, you can diversify your portfolio further by adding other index funds, like a FTSE 250 index tracker, or a worldwide equity tracker. When your capital has built up, it may be more advantageous to pick individual stocks for your ISA.

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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.