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If I were aiming for a five figure income and starting over, here is what I would do today.
1. Open an ISA and/or SIPP
The first thing I would do is look at opening a tax-free stocks and shares ISA or Lifetime ISA. With these products, I can invest up to £20,000 per year (including a maximum of £4,000 at the end).
I would also consider opening a Self-Invested Personal Pension (SIPP). With this, I can invest the equivalent of my annual salary, up to £60,000 a year.
There are advantages and disadvantages to each. Whole-time ISAs and SIPPs, for example, don't allow me to withdraw money until I'm 50. But they offer tax relief to help me build wealth.
Over several decades, ISAs and SIPPs can save investors hundreds of thousands of pounds in dividend tax and capital gains tax savings.
Please note that tax treatment depends on the individual circumstances of each client and may change in the future. The content of this article is provided for informational purposes only. It is not intended to be, and does not constitute, any form of tax advice. Students are responsible for conducting their own due diligence and obtaining professional advice before making any investment decisions.
2. Separate the things I carry
With my ISA or SIPP open, I will be looking to add a variety of different assets soon. I would like to add different shares between 10 and 20 to help me balance risk and reward.
I would aim to gain exposure to multiple sectors to reduce the impact of sector-specific threats and provide smooth returns throughout the economic cycle. And I will make sure that the businesses in my portfolio get leverage from different regions to capture different growth opportunities and spread risk.
3. Cut costs
Having said that, diversification with a small amount of capital can lead to high costs, which can reduce the effectiveness of your investment in the early stages.
If I had £1,000 to spend on Hargreaves Lansdowne Stocks and Shares ISA, and aiming to spread this across 10 different stocks, I would spend £89.50 in total on trading costs. I would also pay £5 in stamp duty, meaning I would probably spend 10% of my disposable income on taxes and fees.
I can solve this problem, however, by buying a single investment trust or an exchange-traded fund (ETF). If I invested all my £3k in iShares FTSE 250 ETF (LSE:MIDD), for example, I would pay a single trade fee of £8.95. And I wouldn't pay anything in stamp duty.
With this fund, I will own around 250 UK equity funds across a range of sectors. Some of the biggest holdings here include financial services providers This is St James's areaa house builder Bellway and hobby dealer Games Workshop.
I will also have exposure to UK and overseas locations. About 30% of the FTSE 250's earnings are generated internationally.
£11,680 passive income
As you can see though, the fund would be very vulnerable to a downturn in the British economy. I would also need to pay an ongoing annual fee of 0.4%, which I would not have to deal with by buying individual shares.
But in the long run, I am sure that this FTSE 250 fund can help me create great wealth. It has delivered an annual return of 8.6% since its inception 20 years ago.
If this continues, a lump sum investment of £3,000 and an extra £150 a month will take me to £291,988 after 30 years. Drawing down 4% of this each year would give me an income of £11,680.
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