If you want to invest your first £5000 on the stock market where is the best place to cut your teeth as a new investor?
Legendary US super-investor Warren Buffett is certain that most investors would be best off choosing a low-cost index-tracking fund. By definition, you should then more or less match the overall return from the market, at the same time side-stepping the transaction costs associated with individual stock trading and the management fees charged by fund managers.
On the London stock exchange, you might go for a tracker fund that follows the FTSE 100 index or the FTSE 250 index, for example, and one candidate is the Vanguard FTSE 100 ETF. However, several options exist to put your money into a collective investment vehicle, including Exchange-traded Funds (ETFs), Investment Trusts and Mutual Funds. My Foolish writing colleague Edward Sheldon penned an article describing these options recently.
Where to begin with individual stocks
A time probably comes to most investors when they feel like individual stock picking. My own investing journey started with privatisation shares in the 80s and 90s, then I bought a fund that tracks the FTSE 100 and finally moved on to individual stocks on the London Stock Exchange. When you are ready to pick your own stocks, it makes sense to start by targeting firms that have large and relatively stable underlying businesses compared to companies with smaller market capitalisations.
The stocks of large firms tend to have good liquidity, which means you can get in and out of the shares without difficulty and without excessive transaction costs. Plus the movements in the share prices of large firms tend to be slower than smaller ones, which can give you time to react with buy and sell decisions as the fundamentals of the underlying businesses change. So a good place to begin with individual stock picking is FTSE 100 Index businesses, but those companies come in various categories that tend to behave in their own unique ways.
Know the beast you're trying to ride
It pays to be clear about what you may be getting into and I think a reasonable place to start is by dividing the stocks in the FTSE 100 into the categories of Defensives, Cyclicals and Growth. If you see a business with strong and stable cash flows supported by products and services that experience high demand whatever the economic weather, you are probably looking at a Defensive. Names to look for include Unilever, GlaxoSmithKline and Diageo.
The cyclicals tend to have underlying businesses that ebb and flow along with economic cycles. Their profits and share prices are as likely to plunge as to soar over an extended period. Examples include Lloyds Banking Group, BP and Ferguson. Finally, successful growth companies often make it to the FTSE 100 and can keep on growing. Think of Just Eat, Smurfit Kappa Group and Sage.
Stock-picking can be exciting, and ace fund manager Neil Woodford is currently investing on the theory that UK-facing cyclicals look undervalued and should do well. Meanwhile, the FTSE 100 is weighted towards cyclical firms, so maybe a FTSE 100 tracking fund is all you need after all, especially considering the theory going around that stocks in general have spent the past 20 years or so setting up, in terms of technical analysis, for a multi-year bull run.
Grow £5,000 to one million
The stock market is a proven long-term wealth generator. Even if you're only starting out with £5,000 now, who knows how much your portfolio could be worth in 10 years' time if you work hard at research and stick to a sound investing strategy.
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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline and Unilever. The Motley Fool UK has recommended BP, Diageo, Just Eat, Lloyds Banking Group, and Sage Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.