Where to invest your first £2k is an interesting question. Let’s assume you’ve saved hard and regularly and now feel ready to follow the advice we often shout about at The Motley Fool – namely that over the long haul, shares have outperformed all other major classes of assets such as property, bonds, and cash savings.
Seeking diversification
I wouldn’t consider investing less than £1k in any one individual company because the transaction costs will likely eat up too much of your capital. I’m thinking of the broker’s trading fee for buying the shares, the bid-offer spread, and stamp duty.
So, the greatest diversification I’d be able to achieve would be to spread £2k across the shares of two stock market companies. However, if that would be your first investment in the stock market I think the single-company risk is still too high. If something goes wrong with the underlying business of one of your shares, half your total invested funds could plunge.
I reckon a collective investment vehicle such as a fund is a far more attractive proposition for your first £2k investment. You could go for a managed fund, which is run by an investing team or fund manager. The idea is that the share-picking is done for you and your investment is diversified across the shares of many underlying individual companies. Indeed, fund investing is a great way to get instant diversification.
However, a managed fund will charge high fees, which will eat into your returns and there’s no guarantee that you’ll happen to pick a fund that performs well. Look at the recent underperformance of the once-popular Woodford funds, for example. One way of getting around the risk of under-performance is to spread your investment between two or even more managed funds, and your £2k investment will be sufficient to achieve that.
Faith in the stock market
But rather than put my faith in individual fund managers, I’d rather trust the stock market itself to do its ‘thing’ and deliver me a decent compounding return over time. To do that, I’d invest in passive, low-cost index tracker funds. These funds offer very low fees and simply aim to replicate the performance of a share index such as the FTSE 100, or maybe the FTSE 250, or even share markets abroad.
Passive index tracker funds come in many varieties, so with a lump sum of £2k, I’d diversify across at least two of them. And one important point is that I’d select the accumulation version of each fund rather than the income version so that the dividends would be automatically reinvested into the fund, thus helping to compound my investment.
After that, I’d switch my monthly savings standing order so that it invests directly into each fund every month on an ongoing basis. I reckon that would be a great start to any investing career, and when the invested funds build up you can consider investing in individual shares alongside the core tracker investments.