Some Advice On ISAs, Spread Betting and eBay Trading

I was emailed by Robin today, who asked for advice on regular smaller sum investing:

"...I would be very interested to see an article discussing some of the best investment opportunities for those with a very limited sum to invest. For instance, I currently put £200 a month into a Halifax medium risk share pool - given the overheads with each transaction this seems a better approach than investing in my favourite companies directly. For my situation is this the best approach, or would a better strategy be direct investing, spread betting, trading on eBay, or any number of other opportunities? An article comparing the myriad of investment opportunities at this scale, and a discussion of longer term strategy and investment diversification would be very interesting..."

Thank you for the message, Robin. It's always great to hear from people that are starting their journey towards financial freedom via intelligent investing.

Firstly, I want to make it clear to others that it is not beneficial to begin investing until you have cleared off all debts (excluding a mortgage), have started to budget properly and have saved up a 'rainy day' liquid cash reserve. There are two reasons for this. 1) As an early investor it will be tough to invest in a manner that will outperform the interest payments on any debt currently held. In addition, 2) If you need access to cash quickly for an emergency or other unexpected reason, it may be a poor time or difficult to sell out of your investments to fund the cash shortfall. Therefore eliminate your debts and have some cash saved first!

Once you are in this position it makes perfect sense to allocate additional spare cash towards investments. As Robin pointed out though, there are so many choices it makes it difficult to decide what to do.

The first consideration is taxation. It will be your largest cost as an investor and so it is necessary to find a tax efficient means of investing your cash. For those resident in the UK, the best vehicle to begin with is a 'Stocks and Shares ISA'. At the time of writing it will allow you to invest up to £10,680 per annum in a tax-sheltered manner, but this is rising to £11,280 for the next tax year. Any gains generated in the year from your investments will not be taxed either as income or capital gains. This is because contributions are made to an ISA with after-tax income, which would otherwise be taxed twice.

ISAs give you a broad choice of investment possibilities, including stock in individual companies, UCITS regulated funds such as unit trusts and 'open ended investment companies' (OEIC) as well as corporate and government bonds ('gilts' in the UK). As a consumer investor, ISAs provide a great choice of investments. There are many firms who provide ISAs, including retail banks as well as fund entities such as NS&I, Fidelity and Hargreaves Lansdown.

However, at Robin's scale of £200 per month, it will be challenging to avoid having any gains in individual company stock eroded by transaction costs. Thus it makes more sense to invest in a collective-scheme, not unlike what Robin is doing now. Depending upon what you believe is likely to perform this year, you could invest a sector-based fund, a bond fund or even gain exposure to the whole market via an 'index tracker'. The annual Total Expense Ratio (TER) is likely to be far cheaper than the sum of all transaction costs that could be incurred by individual corporate stock investing over a year.

Robin also asks about Spread Betting and ebay Trading. Let's start with the former. Spread Betting is a form of leveraged speculation, which allows one to take viewpoints on the direction of a wide range of financial assets and leverage up this view. It is actually a form of financial derivative, but we will concentrate on its importance to a consumer investor.

The three main advantages of Spread Betting are 1) That it is completely tax free (both from income and capital gains), as it is considered a form of gambling under UK law, 2) Positions can be leveraged in order to achieve higher returns and 3) There is a substantial choice of financial instruments to bet on. However, I do not recommend it as a beginner investment activity. This is because it carries the risk of significant downside loss, which can greatly exceed the initial investment if leverage is used incorrectly. It requires an incredibly disciplined and analytical approach in order to make a consistent return over the long run, as well as a great deal of time dedicated to research. Many people gravitate towards it because it is easy to get started with limited capital and provides the potential for large upside. As a beginner investor it is better to stick to simple straightforward methods as a 'first go'.

Note: I will be discussing techniques to become a sophisticated spread trader in a later set of articles.

Robin finally mentions eBay trading. The basic idea here is simple: Buy or obtain items and sell them on for more than they were purchased for, minus expenses such as advertising and postage. eBay trading is nowadays quite saturated so it is best to concentrate on a niche market. Make sure there is demand for any products that might be offered and that after purchasing the items, usually via wholesale, there is still room to make a profit after delivery, packaging and advertising expenses have been taken into account.

The major benefit of eBay is instant distribution availability - the same reason that many people are currently developing iPhone and Facebook applications. The flipside is that all trading has to be carried out with their platform with any associated restrictions or changes. Hence you are 'not in control of your store'. As an entrepreneur, I think eBay trading has a lot of mileage, but it is certainly not a get-rich-quick scheme. It will take a few months, maybe a year, to get up and running towards a consistent profit. As an alternative to traditional share investing, it is attractive, but it does require some time.

In summary I suggest that an index-tracker or a sector fund is a good means of testing the investment waters as the transaction costs, and taxation through an ISA, will be low. In later articles I will answer Robin's questions on diversification and longer term strategies.

Thanks again for your email, Robin. If anybody else has any investing questions, do not hesitate to get in touch.