When looking at potential options for investment, the stock market has hundreds of listed companies. It can be daunting for me to pick a selection with available cash. Even for someone like me, who has been buying and selling for years, I still have to pick my opportunities selectively. When considering how to invest with the £500 of free cash that I have now, here’s what I’d do.
My top-down approach
Before picking specific stocks, I like to begin with a top-down approach. This means considering the big picture first and then working down to sectors and individual shares.
At the moment, my big picture view is that the next year is probably going to be tough for the world economy. The UK is very likely to be in a recession by the end of this year. This is being driven by high energy costs, high interest rates, and a lack of growth in the economy.
However, I see this recession primarily being caused by the war between Russia and Ukraine. I think we’ll eventually get a resolution here, which should help to support a global recovery as supply pressures ease.
With this thinking, I can then filter down to specific areas in the stock market. For example, I want to allocate most of my £500 to defensive stocks. This would include the likes of supermarkets, utility companies, alcohol and tobacco brands, and others. I’d also tag in banking shares as being defensive enough to withstand the tough period ahead.
Picking the right stocks
Within each of my target sectors, I want to aim to pick the right stock. For example, supermarkets. I’d favour buying Tesco shares over more high-end grocers such as Ocado. I think consumers are likely to try and find cheaper food options with the cost-of-living crisis. I also want to consider the dividend yield, profit margins, and other factors. After all, I might make the correct call on a sector doing well, but I don’t want to lose out by my specific firm doing badly.
I can reduce this risk by picking a few stocks from each of my preferred sectors. However, let’s say I choose four sectors, with four stocks in each. That’s 16 shares in total! Although this does diversify my risk, with £500, I’m only going to have around £31 in each. After taking into account trading costs, I’m not really going to benefit from any stock doing well.
Rather, I feel I can achieve diversification by picking half a dozen stocks in total from the four sectors. My risk is spread over different areas of the market. Yet I still have enough cash in each stock to benefit if one does very well.
How to invest for today and the future
I feel I can invest my £500 well based on my top-down approach into defensive sectors. Yet I also need to remember that I’m going to have more money in coming years to invest. Therefore, during a recovery in the market my investment strategy would shift to more aggressive growth stocks. Learning to invest is a constantly evolving process for the long-term thinker!