Cash ISAs remain the most popular destination for savings. While they offer no risk of capital loss and an interest income, they may not be the best home for your spare cash.
By contrast, investing in the stock market may seem to be out of reach for many people. High costs, the risk of losing money and the volatility that is often a central part of being an investor dissuade many savers from seeking a higher return on their money.
However, investing in the stock market may be possible for savers who have even modest sums of money available. With that in mind, here’s how I’d invest £500 today.
Reduced risk
While buying company shares can generate high returns over the long run, it can lead to significant risks if a portfolio is not adequately diversified. Since the cost of investing £500 across a variety of companies would lead to high commission costs, it may be prudent to instead consider a tracker fund.
With the cost of passive investing having fallen significantly in recent years, it is now possible to invest in a tracker fund and pay under 0.2% per annum in ongoing charges. This makes it an efficient and low-cost means of investing in a wide range of companies. For example, a FTSE 100 tracker fund invests across the entire index, which reduces the risk of one or more stocks experiencing a difficult period and hurting the performance of the investor’s entire portfolio.
Potential returns
Of course, the potential for a downturn in the wider stock market remains when investing in a tracker fund. However, over the long run the FTSE 100 and FTSE 250 have historically always recovered from downturns. Therefore, if an investor is able to take a long-term view, there is a good chance that there will be a full recovery from a challenging period.
In terms of return potential, the FTSE 250 illustrates the growth that can be achieved from investing in the stock market. Over the last 20 years it has recorded annualised total returns of over 9%. This would have turned a £500 investment into over £2,800 during the period. And, with the index having experienced two major bear markets during that time (the dotcom bubble and the financial crisis), its performance could be realistic when looking at the next 20 years.
Account opening
With a Stocks and Shares ISA offering the opportunity to pay no tax on dividends and capital gains, using it to buy a tracker fund could be a shrewd move. With the costs of ISAs having dropped significantly, it could allow an investor to generate a significant return on their investment over the long run.
Of course, buying company shares within a Stocks and Shares ISA may also prove to be a worthwhile move. However, for an investor with £500 to spare, a tracker fund could be a good place to start from a risk/reward perspective. With a larger sum, the next step could be investing in company shares in order to try and beat the wider index.