Imagine, you have been left £10,000, are not yet 30 years old, and want to build a solid foundation for a long-term savings plan. How should you go about that?
How to invest £10,000
Tax is crucial: it can make a big difference to investment returns. In the UK, there are tax-efficient SIPPs (Self-invested Personal Pensions) and ISAs (Individual Savings Accounts). There’s also the GIA (General Investment Account), but it offers no tax benefit.
How can I be sure?
The long future ahead of a young investor holds the usual uncertainties, but coupled now with unusually high geopolitical risk in a polarised and changeable world. Flexibility is at least as important as tax-efficiency, therefore. You need easy access to your money if there’s a change in your circumstances or in the markets.
An ISA is best. You can invest up to £20,000 annually and any income from it is free of tax. So are capital gains although, unlike a SIPP, an ISA will count towards Inheritance Tax liability. Also unlike a SIPP, however, you can withdraw all or part of your money at any time.
An all-equity ISA is appropriate. Younger investors should embrace equities more than bonds or cash; they have the time in which to reap the greater reward of taking the greater risk of shares. This chart leaves no doubt (shares versus bond performance).
Fee, fi, fo, fum
Investing directly in shares is neither practical nor sensible, however. Your £10,000 is not enough to spread across a selection that’s diverse enough to reduce the risk of any one issue. That means you should invest in funds, but you must be careful account about their fees.
Fees eat into returns, especially in the low-growth environment that most analysts now expect for many years to come. Actively-managed unit trusts, OEICs (open-ended investment companies), and investment trusts have annual management charges that, in a few cases, are as high as 1.5% of your investment. Here are the worst offenders as of August 2022.
Invest passively, therefore, with ETFs (exchange-traded funds). Although they are higher than tracker funds – Vanguard’s FTSE100 unit trust charges just 0.09% – ETF fees are much lower than those for active funds and they have no initial charges. That’s because they’re listed on the stock exchange, just like shares, and can be traded quickly and easily on any business day with low or even nil commission.
No place like home
The majority of your ETFs should be invested in UK equities because the liabilities for which you’re saving are in this country. Besides, the ‘Footsie’ is estimated to offer fair value.
Your choices should favour big funds (better liquidity) managed by big names (better resources) with low total expense ratios (TERs). Those requirements are met by iShares Core FTSE 100 UCITS ETF, managed by BlackRock, and Vanguard FTSE 100 UCITS ETF, both having TERs under 0.1% p.a. and assets of a billion or more apiece.
All the small things
With 60% of your portfolio allocated to one of these or, for diversification, both, you can boost returns by devoting the remainder to smaller companies and emerging markets. For only a little more risk, their potential for above-average profit growth should deliver better returns than those for the 100 largest UK companies alone.
Smaller companies and emerging markets are costlier to manage, so TERs are higher. My choices are the iShares MSCI UK Small Cap UCITS ETF (assets: £187 million; TER: 0.58%) and the iShares Core MSCI Emerging Markets IMI (assets: £17 billion; TER: 0.18%).
Finally, every month, invest as much as possible of your salary in this foundation portfolio. At just 5% growth annually, compounded, and with small contributions of only £200 a month, it will be worth more than £200,000 in 30 years.