Having a Stocks and Shares ISA is a no-brainer for the vast majority of private investors, even if they just want to stick with FTSE 100 shares. After all, any profits you make, or dividends you receive within this account, won’t be taxed. That’s a big positive when you consider the life-changing power of compound interest coupled with the fact that you can currently put up to £20,000 to work in the markets every year.
So, what sort of strategy should someone adopt if they have the full allowance to invest but only want to pick from the UK’s biggest companies? Here’s my take.
Buy ‘quality’ FTSE 100 shares
While it’s too soon to know the full economic cost of the coronavirus, one way of mitigating its impact on your wealth is to seek out quality stocks.
Now, it would be a mistake to assume that all FTSE 100 shares are worthy of your cash. A company can be huge (and trading on a cheap valuation) and yet actually be a very poor investment if, say, it operates in a crowded sector. Poor earnings growth, high fixed costs, and big debts can also hold it back.
My preference, therefore, is for companies with great brands, sound balance sheets, and/or large market shares. I’m also looking for firms that earn above-average returns on the money they invest in their businesses. Think of this as their own ‘interest rate’, just like you’d get with a savings account. Anything above 20% or so, gets my attention.
This is why I own a stock like Rightmove. It’s suffering in 2020, but I’m confident that boasting the above qualities will help it bounce back, in time.
Diversify (but not too much)
Buying quality still counts for little if you’re only investing in one or two parts of the market. You don’t need me to tell you how horrific 2020 has been so far for those companies operating in the airline sector (easyJet, IAG) and the oil industry (Royal Dutch Shell, BP). Spreading your cash around is prudent.
Having said this, it’s also a fact that the more FTSE 100 shares you hold, the more closely your portfolio will resemble the index. That’s problematic, because the goal of stock-picking should be to beat the return of the index, not replicate it. You may as well buy a cheap exchange-traded fund, accept the market return, and do something else.
Another reason for buying only your best ideas comes down to management. The larger your portfolio, the more time and energy you’ll need to expend staying in touch with your holdings.
Expect volatility
Pick up any financial paper at the moment and you’ll get a mish-mash of people saying that stocks will hang on to their recent gains and others saying that we’re heading for another leg down. To save you pondering things any further than you need to, I can confidently say it’s pretty much impossible to know with any certainty.
What I think we can expect over the next few months is volatility. This being the case, it may be worth investing your money in installments. Pound-cost averaging (investing the same amount on a monthly basis, for example) into FTSE 100 stocks is psychologically much easier than investing all in one go. It should also help to smooth out returns over time.