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Starting an investment portfolio of UK shares doesn’t require much initial capital. In fact, an investor with only £500 can get the ball rolling. But there are some critical factors to consider when deciding how to invest this money, especially when it comes to trading costs.
Even the investing platforms that support commission-free trading have hidden fees that can eat into returns. And we can’t forget about the taxman. Using a Stocks and Shares ISA solves the latter issue but often comes with higher account costs. And it doesn’t grant immunity to stamp duty, a 0.5% transaction tax.
Executing lots of transactions will eat into the £500. So how exactly can investors build a diversified portfolio of top-notch UK shares with only a small lump of capital? Let’s explore some options.
Leveraging the power of funds
Instead of trying to build an investment portfolio of UK shares manually, an alternative is to let a professional handle everything. Private investment advisers can be expensive and likely won’t even consider managing a £500 portfolio. Fortunately, a far cheaper alternative exists – funds.
Instead of buying individual stocks, investors can buy shares in a mutual fund, or exchange-traded fund. In oversimplified terms, these investment vehicles pool the capital of thousands of other investors into a single pot. They then use the combined wealth to invest in a collection of stocks and other securities to generate returns.
This not only puts an investment portfolio on autopilot but also provides instant diversification within a single transaction. There are annual management fees that can eat into total returns. However, sticking to low-cost index funds can largely make this expense negligible.
Can I pick stocks with £500?
A common drawback with funds is that they rarely deliver market-beating returns consistently. By picking individual UK shares, an investor can unlock substantially more wealth, assuming, of course, they can identify winning long-term investments.
However, as previously mentioned, when trading fees are considered, £500 can only realistically be split across two or maybe three positions. Anything more, and a portfolio has to do quite a bit of legwork before breaking even.
For example, suppose I were to invest £100 across five stocks, and the average trading fee for each transaction is £10. In that case, my portfolio would need to deliver a roughly 10% return just before any profits begin to materialise. So how is an investor supposed to build a diversified portfolio?
There’s no rule that states an investment portfolio needs to be diversified on day one. Suppose an investor knows they will have more capital available in the future. In that case, they could invest the £500 into a single high-quality position today. And in the future, do the same with a different stock, repeating the process until a portfolio reaches a diversified state.
This technique does open the door to significantly more volatility than investing in a fund. However, it can potentially lead to far superior returns in the long term.