One of the most tax-efficient ways for UK residents to start investing is via a a Stocks and Shares ISA. Even with as little as £1,000, here’s how I’d get started on growing my savings.
Advantages of an ISA
For anyone living payday to payday, accruing savings can take some time. So I wouldn’t want to squander my effort. That’s where the advantages of an ISA come into play.
With an ISA, investors can invest up to £20,000 a year into assets of their choice. The key benefit is that any profits made from the investment are tax-free.
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Diversity is key
Investing all my savings in one stock wouldn’t be smart, no matter how much I believe in it. It’s best to spread the investment over 10 to 20 different stocks from various industries. That way, any single failure or industry-specific slump would only have a small effect on my portfolio.
Volatility in the stock market is inevitable so diversifying a portfolio is the best way to minimise risk and optimise returns.
Reap the rewards
I’d invest in potential growth stocks — that is, shares where I expect strong price growth. But I’d include some stocks that pay dividends too, and hopefully that combine both features. These are returns paid in addition to any profits made from share price growth. Dividend-paying stocks typically exhibit have growth potential but the returns are more stable and reliable.
I can take this money as cash when it’s paid or reinvest it into the ISA, compounding the returns and further growing my investment. Over time, this can really make a big difference, as the investment grows exponentially.
One stock I’d chose
Based on the above criteria, one stock I’d choose for my ISA would be Rio Tinto (LSE: RIO).
This major mining conglomerate is up 430% in the past 20 years, equating to annualised returns of 8.72% per year. But it has a 6.2% dividend yield – significantly higher than the FTSE 100 average. Rio Tinto has had its ups and downs over the years but overall, exhibits good long-term growth potential. Due to the consistent and high demand for certain minerals, mining is a relatively reliable industry.
However, it comes with risks. With mines in South Africa, Madagascar and Mongolia, there’s the ever-present chance of political unrest interrupting operations and threatening revenue. Furthermore, new regulations aimed at addressing environmental concerns could be costly for the company.
Solid financials
Financially though, Rio Tinto is in a good position. With only $13bn in debt outweighed by $56bn in equity, it has a comfortable 23% debt-to-equity ratio. Liabilities are well-covered by assets and its interest coverage ratio is 15.2 times. So there’s no immediate danger of cash running out or defaulting on loans.
However, the shares could be a little overpriced at £55. Using a discounted cash flow model, analysts estimate a price of £49 would be fairer. But with a forward price-to-earnings (P/E) ratio of 9.9, well below the industry average of 17, the shares still look like a good deal to me at this price.
In addition to Rio Tinto, I’d add a bank share like Lloyds, one or two energy shares such as BP, something in pharmaceuticals, and a defence stock or two. Top it off with a reliable investment trust and I think I’d have a well-balanced portfolio.
