Stocks and Shares ISAs make a lot of sense for investors because all gains are free from tax.
And I reckon investing a regular monthly sum, such as £250, is a smart way to go about the business of investing. We can’t stop the stock market indices and individual share prices moving up and down. But we can iron out some of that volatility in our own share portfolios by investing regularly.
The power of pound-cost averaging
By taking a monthly approach to investing, you avoid the risk of putting all your money in when the market hits a high. And when shares retreat, you’ll be getting more for your money, assuming the shares rebound higher again later. The process of regular investing like that is sometimes called pound-cost averaging.
And pound-cost averaging is a great way to invest your money when you are aiming to compound it. Building wealth by focusing on compounding means you’ll aim to plough all your gains back in. So, every time you receive money in the form of dividends, for example, back into shares it goes. And if you sell an investment to realise a gain, you buy another investment with the proceeds.
We know two main things about the process of compounding. Firstly, small increases in your annual gains multiply out to large increases in the amount you eventually end up with. Secondly, your compounded gains accelerate over time, so the largest absolute returns will arrive in the later years of a period of compounding.
We need to achieve the highest annual return we can and compound those returns for as long as we can. And shares as an asset class have historically outperformed all other major classes of assets, such as property, bonds, and cash savings. So, I’d target shares and share-backed investments for my Stocks and Shares ISA.
Ways to invest
One way of investing is to be completely independent and pick your own shares after researching the underlying company. But to do that well you’ll need to put more time into researching and managing your investments and learn all about investing strategy.
But with a regular monthly investment of £250, I’d be more inclined to invest passively in collective investments. You could go for managed funds, in the hope that the fund manager will outperform their benchmark to justify the higher fees. But that doesn’t always work out, as Neil Woodford demonstrated recently.
My choice would be low-cost index tracker funds, and there are many to choose between. But one key point is that I’d choose the accumulation version of each tracker fund I selected rather than the income version. That way, the dividends paid by the fund will automatically be ploughed back into your fundholding, which will set you off on the road to compounding your investment.