If you have just opened up an ISA, you will be walking a path thousands of others have taken.
Being a prudent individual, no doubt you’ll be looking at the historical returns of the funds you may wish to invest in. You’ll be delving into what companies it has a position in, the size of the fund, and any dividends it may offer.
If you’re taking the DIY stock-picking route, you’ll be doing your own due diligence. Financial ratios, company news, investigations into its competitors, and reading about the management will all probably be necessary steps when you choose a business to buy a part of.
These are all important steps. A business or fund should have a lot of boxes to tick before you part with any of your hard-earned cash.
But I think this step – maximising returns – often takes precedence over something much simpler, and arguably more important, for investors just starting out.
Saving
For simplicity, let’s imagine an investor has chosen to invest in a FTSE 100 index fund.
In this example, our imaginary investor has started with a lump sum of £1,000. Last year, the FTSE 100 increased by 11%. This means your £1,000 would have grown to £110 before any fees or dividends are added to the equation.
That may sound impressive. And it is.
But what I think we often overlook is how much we save in our ISAs. In the first few years, this can really ramp up the size of your portfolio, allowing it to compound over the years.
If you invest £96.15 a week, you would have put away £5,000 in a year. Suddenly that initial figure of £1,000 has increased by five times, without any investment growth, dividends, or fees.
That figure may seem unachievable for some people, especially those starting out in their careers. However, with a few sacrifices, I really think it could be realistic for most of us.
Making the cut
How can we save this amount each week? Let’s take a look at our imaginary person’s spending habits, and how we might make a few tweaks to hit a savings goal of £96.15 a week.
According to a survey by bar operator The Deltic Group of 2,300 people in July last year, the average cost of a night out is £70.56. It’s not unreasonable to suggest some people spend this amount at least once a week. For now, our imaginary person is going to prioritise financial independence, so they’re cutting down on one night out a week.
Then consider that buying lunch can cost £5 per day, or £25 a week. Let’s say it costs £2 to make a sandwich at home. This would be a saving of £15 a week.
And then there is the gym membership they might have, rather than doing home-workouts. A gym membership can easily cost £40 per month, or £10 a week.
Let’s cut out driving for shorter journeys, too, by walking instead. Saving £1 a week in petrol costs.
Overall, this saves them £96.56 a week, hitting just over £5,000 a year.
Investment returns are clearly important. But initially, I think we should put more emphasis on ramping up the amount going into our ISAs and investment vehicles.
Then we can let compound interest work its magic.