It wasn’t too long ago that I started investing in stocks with precisely £1,000 in my account. Foolishly, I put half of that amount into one stock. Luckily, that stock turned out to be ARM Holdings (now private) and I profited from it immensely. However, things could have easily gone the other way.
Now, I know just how risky it can be to make the wrong bet and just how rewarding it can be to take the right steps and apply the dynamics of compounding over the long term to create sustainable wealth.
With that in mind, here’s what I would do if I was starting all over again with just £1,000.
Pick a goal
There’s no point in investing without a specific end-goal in mind. Randomly picking stocks from different industries with different characteristics will ruin your long-term performance. Instead, think of your money as a tool that you can leverage to create a specific outcome.
If you’re looking to protect this amount, you may want to take a closer look at fixed-income exchange-traded funds that offer a steady return. Vanguard’s U.K. Short-Term Investment Grade Bond Index Fund is a good option.
However, if you’re looking for higher income, you may want to focus on high-yield dividend stocks. According to fellow Fool Rupert Hargreaves, the top 10 dividend-paying FTSE 100 stocks offer an astonishing average yield of 8.8%.
However, even an 8.8% yield on £1,000 isn’t good enough for me. I prefer companies that hold onto their cash and reinvest it in a business with stellar potential for growth. Software firm Kainos Group, for example, has been expanding its asset value by roughly 26% since 2013.
At that rate, £1,000 could turn into £10,000 in 10 short years. That’s the sort of bet I like.
Once you’ve figured out if you’re a conservative investor seeking regular income or a growth-hungry investor looking for wealth creation, the next step is to minimise your risk of losing money.
The easiest way to do this is to spread your bets. Don’t make the same mistake I did and pour half your capital into a single stock. Instead, aim to spread the £1,000 evenly between six to 10 different opportunities. This limits the potential downside for your portfolio.
But don’t over-diversify
Most financial advisers are quick to point out the value of diversifying your portfolio. However, very few would warn you against over-diversifying. Spreading yourself too thin isn’t as risky as not diversifying enough, but it can impact your long-term performance.
Research indicates that the impact of diversification diminishes after the 20th stock. Which means there is very little difference in the amount of risk exposure for a portfolio of 20 holdings compared to one with perhaps a 1,000 holdings. However, a 1,000-holding portfolio is much more complicated to create and manage effectively.
Don’t waste your time and effort. Pick a handful of excellent stocks and watch them closely.
If you’re just getting started with investing in shares, I recommend picking a long-term strategy for your investments and spreading your bets appropriately.
VisheshR has no position in any of the shares mentioned. The Motley Fool UK has recommended Kainos. 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.