One of the reasons many people decide not to start investing in shares just yet is because they want to wait until they have more money to invest. The logic is understandable: investing takes time and costs can eat into returns. Investing just a small amount of money can seem like more effort than it is worth.
But actually, I think the best way to start investing is with a fairly modest amount of money. That is why, if I had a choice between £50,000 and £500, I would rather begin my investing journey with just £500. Here is why.
Learning by doing
Before they start investing, many people think they could make great stock pickers. When it comes to putting hard cash into companies, though, things can be more complicated than they look from the comfort of an armchair.
Most people make mistakes when they start investing. For example, maybe they look at Vodafone’s earnings but do not think about its €44.3bn of net debt. Maybe they look at the Tate & Lyle sugar in their kitchen cupboard and fail to realise that it is not produced by the listed company Tate & Lyle. Maybe they look at Ferrexpo’s 12% yield and do not understand that it is funded by mining operations in Ukraine.
I think making mistakes can be an important part of learning as an investor. Some errors could actually turn out in my favour. But probably some mistakes will cost me dearly. If I start investing with £500, my education could come cheaper than if I begin investing with £50,000.
Focussed diversification, not money spraying
A key principle of risk management when investing is diversification. Nobody knows how a company will do in future. By spreading one’s investments across different companies, the risk to a portfolio from any one company is reduced.
The thing is, it can be hard to diversify with £500. Many stockbrokers charge a minimum fee for each transaction. So if I buy shares in lots of different companies, my £500 could largely be eaten up just in dealing fees.
That sounds like a bad thing – but I actually see a positive side. I would still want to diversify, even if only by putting £250 into each of two companies. But the limited diversification I could manage with £500 would motivate me to consider each investment very carefully. By contrast, with £50,000 I could easily spread the money across a couple of dozen companies. That would help me diversify – but I may pay less attention to the merits of each individual company.
By contrast, forcing myself to diversify with £500 could focus my mind on the quality of my investment choices more than if I had £50,000 to spray across a wide selection of shares.
How I would start investing
Of course I would like to be able to invest large sums in successful companies.
But that is not how I would choose to start investing. Instead, I would aim to begin on a relatively small scale. That way, I could focus on choosing just a few companies for my portfolio – and learn from my experiences with them.