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£500 to invest? Here’s where I’d invest money in a Stocks and Shares ISA

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I glanced at a headline recently about a young adult who’d taken his life savings from an NS&I savings account to invest money in a Stocks and Shares ISA.

All that birthday money and savings from paper rounds, taken from a ‘safe’ National Savings and Investments account and ‘risked’ on the stock market. Is it a good idea? You bet it’s a good idea. Let me explain why.

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Why I’d invest money rather than save it

A quick glance at the NS&I website reveals the top interest rate for cash savings is around 1%. I can understand why many would be attracted to NS&I because it’s backed by the UK government. But if you compound your savings with that rate of return over decades there’s a good chance the value of your savings will fall. Indeed, the rate of general inflation tends to run higher than 1%. So the spending power of your money could decline over time.

Meanwhile, over the long haul, the general stock market has historically returned an annualised figure in mid-to-high single-digit percentages. Sure, there have been ups and downs along the way, but averaging the return over decades and expressing it as a yearly figure is encouraging. It beats cash savings hands down.

You can open a Stocks and Shares ISA when you are 18. And that’s a great age to begin investing. With your entire adult lifetime ahead, you have plenty of time to compound your investments. And the principle of compounding is key to building wealth. Just like interest builds up in a cash savings account, you can plough back all your returns from shares too.

The wonderful characteristics of compounding

And those returns will arrive in the form of shareholder dividends or lumps of capital if you sell an investment. Put them all back into shares and those returns will earn further returns and so on. Meanwhile, the great thing about compounding is it accelerates and grows exponentially over time. If you compound for 40 or 50 years, you could be amazed by the sheer size of your annual returns towards the end of the period.

That’s why starting as young as you can is a great idea. If you are 18 now and savvy enough to understand the benefits of compounding investments, I envy you! But don’t stop with an initial lump sum of £500 or so. Maybe you can make regular contributions through your working life. Perhaps you could set up a monthly payment into your Stocks and Shares ISA when you start earning at work.

To begin with, I’d think about allocating my money into low-cost tracker funds within the Stocks and Share ISA wrapper. If you select the accumulation version of the fund (rather than the income version) it will automatically roll the dividends back in for you and set you on the path to compounding. I’d keep it simple, to begin with, and consider trackers that follow the FTSE 100, FTSE 250, and the US S&P 500 indexes. Maybe later you could diversify into investment trusts and shares of individual companies. Many investors do that to secure even greater returns from the stock market. Good luck on your investment journey!

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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.

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