ISA ideas: I’m a beginner investor, where should I put my first £1,000?

Every investor has to start somewhere, and even a £1,000 lump sum is better than a standing start. But the prospect of trying to identify which types of investment are most appropriate for a beginning investor can be daunting.

It only really makes sense to buy a single investment with such a small sum, because each purchase costs money and nibbles away at the amount you actually invest.

Investment funds are a good option because they pool your money with that of other investors to provide exposure to a whole basket of holdings in a single wrapper, thereby providing instant diversification.

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The principle of diversification is a central one to successful investing. If you put £1,000 into a single share - say BP (LSE:BP.) - it may do very well because there’s another energy crisis and oil prices shoot up. But oil prices might fall after you invest; or worse still, the company might suffer another disaster along the lines of the Deepwater Horizon spill in 2010, causing huge damage not just to the marine environment but also to company finances and your share price.

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By investing in a fund holding tens, or in some cases hundreds, of company shares operating in many different sectors (and countries if you take a global view), you reduce the impact of any one share’s fortunes on the whole portfolio.

You can further diversify by mixing shares with other asset types such as bonds (fixed interest investments) in a multi-asset fund. A mix of asset classes tends to smooth overall returns, because some types tend to do well when others are struggling.

As Gavin Haynes, investment consultant at Fairview Investing, points out: “For most investors it makes sense to have a multi-asset fund for their first venture into investing, as not having all their money in the stock market can help dampen the volatility and may result in fewer sleepless nights in turbulent times.”

The first choice facing you is between passive and active funds.

Passive funds - also known as trackers - automatically mirror the constituents and weightings of a specific market index, and therefore follow its movements up and down over time.

Active funds are run by a fund manager (or team) who research, analyse and select individual stocks for the portfolio, and then monitor it to ensure it stays on track with its objectives (growth over the medium term, for instance, or a certain level of dividend income).

Active funds, because they’re run by human managers rather than algorithms, tend to be more expensive. There is also scope for them to do better or, more typically, worse relative to the index they are benchmarked against.

For a starting investor, Justin Modray, founder of Candid Financial Advice, recommends a mainstream index-tracking fund, to reduce both the costs involved and the risk of picking a disappointing actively managed fund.

“Investors wishing to track just the UK stock market could look at FTSE All-Share trackers from the likes of Fidelity, HSBC or L&G,” he says.

“Alternatively, the Vanguard LifeStrategy range offers a simple one-stop shop for global stock market and fixed interest exposure, with options for 20%, 40%, 60%, 80% and 100% stock market exposure (with the balance made up by fixed interest).”

If you are comfortable with greater volatility as well as potentially higher returns and can leave your investment for several years, Vanguard’s 80% or 100% stock market options may appeal more to you. Whereas, if you want a steadier option or have less time, choose a lower proportion of equities.

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Vanguard’s LifeStrategy family is also highlighted as a great starting choice by Haynes, and three of the funds are also part of interactive investor’s Quick-start options for beginning investors.

If you prefer the idea of managerial control rather than being tied to the vagaries of the market, Haynes picks out the CT Universal MAP multi-asset funds, which “offer a low-cost route to active management (with yearly ongoing charges of just 0.29%) and have built up a good track record”.

For suitable active choices with a sustainable focus, ii offers CT’s sister Sustainable Universal MAP range as a marginally more expensive Quick-start selection, while Haynes favours Royal London’s Sustainable funds, run by the highly experienced manager Mike Fox.

If these cheap, broad-based funds are the way forward for beginning investors, it’s also worth highlighting the kind of investments they should steer clear of at all costs.

Diversity, as we discussed above, is a fundamental investment principle, and one of the most obvious risks is that investors at the start of their journey might have their heads turned by much more focused or concentrated funds.

As Haynes observes: “A common pitfall for first-time investors is to favour a high-risk area that has made headlines because it has performed very strongly. It’s always worth remembering the golden rule that past performance is not necessarily a guide to the future.”

He therefore counsels against single-sector or single-country funds – “anything too niche” – while Modray advises that new investors should avoid even broader-based investments that could be potentially volatile, such as smaller company or emerging market funds.

What happens next?

It’s important to recognise that while £1,000 invested is not to be sniffed at, if you leave your investment venture at that, you’re not really going to feel significant benefit. Ideally, it will be the foundation on which you build through regular monthly contributions from income - and, of course, you can always add further lump sums too, if they come your way.

Modray points out that saving even £25 a month “could be worth many thousands if you can save over the long term”. For instance, the Candid Money’s “how much” calculator shows that if your initial £1,000 plus £25 a month grew at an average 6% over 30 years, it would be worth more than £30,000 by the end of that time (or £18,500 allowing for 2.5% inflation each year).

“A bigger pot will also make it easier to diversify by holding a wider range of investments, and may benefit from more cost-effective platform fees,” he adds.

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A flat-fee structure such as that used by interactive investor, for instance, means that as your investment grows, the sum going out as platform fees becomes progressively smaller in percentage terms.

Regular saving is also in itself a useful way to reduce the impact of volatility, through the process known as pound-cost averaging. If you’re saving through market swings, then when markets are down your money buys more units, and when they’re up it buys less.

Overall in such markets, you’re likely to come out with more units (ready to increase in value once the market picks up again) than if you’d invested the whole sum at the start of the period - so the average cost per unit is lower.

Branching out

So, if you use your lump sum to kick-start a new regular savings habit, and you’re watching your investment gradually grow through a combination of investment growth and contributions, at what point is it worth thinking about adding a second fund?

There are no hard and fast rules here. You may decide to set yourself a goal of say £10,000 before diversifying into another holding, or branch out at the £2,000 level.

“I think it's more about experience than fund size,” comments Modray. “Most investment platforms allow you to mix and match funds with small balances, so it's more down to how comfortable you feel selecting and monitoring more funds.”

Provided you do feel confident fund picking, diversification should be your guide: if you’re holding a global index tracker, there’s not much point in opting for another global fund because you’ll potentially duplicate what you’re already holding. Even a mainstream US fund will run the same risk, as the US market makes up a large proportion of any global index.

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Haynes suggests aiming for a blend of fund approaches: “I think a good starting point is to have a mix of passive and active management so if you have started with an active fund then go for a passive, and vice versa.”

A further useful principle is known as “core and satellite”, whereby you keep most of your money in your original “core” investment, but then gradually add on small “satellites” of interesting and perhaps more focused funds that provide a good contrast to the core in terms of region, market capitalisation, sector, investment style, or even asset type.

As a new investor, you have an exciting and potentially very rewarding journey ahead of you – so make sure you’re disciplined, well prepared and committed to the investment path.