With a fresh tax year under way, I now have a whole new Stocks and Shares ISA contribution limit. What should I do with it?
I could aim for short-term income, or pick some companies I think might soar in the next year or two. But as a long-term investor, what I would like to do is use my ISA to try and build long-term wealth.
Here are four principles I will apply when aiming to achieve that goal.
Always diversify
Diversification is a simple but important risk management tool. No matter how good I think the prospects for a business may be, if I put too large a proportion of my Stocks and Shares ISA into it and things turn out differently to my expectations, that could be a costly mistake.
With an ISA allowance of £20,000, diversification ought to be possible. If I used my full allowance in the coming year, for example, I could comfortably spread my funds over five to 10 different shares.
Focus on proven business models
One of the tussles I have in my investing strategy is whether to invest in income or growth shares.
Growth shares come in all shapes and sizes. Some fast-growing businesses have a proven business model that is already highly profitable. Others do not, though.
Renewable energy is a good example. I expect that some companies in the sector will make profits in the future – possibly big ones. But at the moment, firms like ITM Power and AFC Energy are lossmaking.
Is that just a growing pain, or a sign that they might not have an ultimately successful business model? I do not know, which helps explain why I do not own shares in either.
In my Stocks and Shares ISA this year I plan to focus on buying into firms with already proven business models. Past performance is not necessarily a guide to what will happen in future, but usually a company with an unproven business model is too speculative for my tastes.
Compounding dividends
How could I turn £20,000 invested in my ISA this year into £200,000 even if the shares I buy do not go up in price?
One way would be to invest the money in shares that compound at 7% annually for 35 years.
Dividend yields may change over time. But I think compounding the dividends I receive within my ISA could be a powerful way to help me build long-term wealth.
Avoid unnecessary risks
All shares carry some level of risk. Some, however, are clearly riskier than others.
The argument some investors make for owning such shares is that they are ‘high risk, high reward’. By investing in risky shares, they hope to do very well if those shares perform strongly. That sometimes happens.
But over the long term, a few risky shares can hurt results badly. I want to invest to make money, not lose it!
So this year, when investing in my Stocks and Shares ISA, I will be trying to avoid shares I think look even moderately risky. Rather than trying to maximise my returns, I will focus on reducing my risks – and hope that some well-chosen shares can perform well for me over the long term.
This post was originally published on Motley Fool
