While it would be nice to have a seven-figure sum to invest in shares, for most that's unfortunately not possible. Certainly, it is possible for almost anyone to end up with a portfolio worth £1m+, but starting out with a much lower amount can be tough.
One area often overlooked by investors is the cost associated with buying and selling shares. Even though the internet has significantly reduced transaction costs, the reality is that with £1,000 to invest, a significant part of their profit is likely eaten up in charges.
For example, a competitive online broker is likely to charge up to £15 per transaction. When 0.5% stamp duty is added, it equates to a fall of 2% in the return on that £1,000 investment. With the cost of selling factored in, plus the spread between the bid and the offer price, an investor may need to generate a total return of 3.5%+ before they even break even. Given that shares generally return 7-8% per annum, that means up to six months of returns are paid out just in charges.
Therefore, it makes sense to try and keep costs to a minimum when investing relatively small amounts. One way of doing this is to adopt a buy-and-hold strategy, which means the volume of transactions is relatively low. Another way is to utilise aggregated orders. They're available through most online brokers and while they reduce flexibility, they also cut buying costs by around 80%.
Of course, someone who has £1,000 to invest in shares should still seek to diversify in order to reduce risk. One way is to buy a tracker fund. It aims to track the performance of the FTSE 100, or whatever index it is designed to follow. While its performance is unlikely to perfectly mirror that of the index due to tracking error, it should provide a result that is very close to the real thing. And with tracker funds generally having low charges, the total returns on offer could be significant.
Tracker funds also provide flexibility in terms of investing small amounts on a regular basis, which makes them ideal for smaller investors. And with the FTSE 100 yielding 3.9%, they could make a more rewarding, albeit riskier, alternative to savings accounts. With inflation being at around 3%, they could provide a means of obtaining a real income return over the medium term.
Certainly, buying shares in individual companies rather than purchasing a tracker fund can lead to the prospect of outperformance in the long run. It could mean that you're able to generate double-digit returns per year. But for an investor starting out with £1,000, a tracker fund may provide a more cost-effective solution in accessing the growth potential which the Footsie has to offer.
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