The Bank of England has warned us that the UK faces its longest recession in a century. So, starting a Stocks and Shares ISA might not be a high priority for many right now. But I think those who can get started today have the potential to do especially well over the long term.
ISAs are more popular when the economy is going well, stock markets are strong, and company profits are growing. But shares are more likely to be fully valued then, with fewer bargain buys around.
Good times generate demand for shares, and that pushes prices up. But when people are feeling the pinch and have less to invest, stock market enthusiasm falls. And that can mean lower share prices, and better dividend yields.
Dividend yields
The Legal & General share price, for example, has fallen 20% over the past 12 months. But its forecast dividend yield now stands at 8%.
Anyone who bought shares a year ago would be set for a yield of about 6.3%. That’s simply because they’d have paid more for the shares, and the same dividend cash would be a lower percentage of that.
Taylor Wimpey is another example. Its shares are down 40% in 12 months, with the forecast dividend yield up to 9.5%. Buying a year ago, an investor would be looking at only 5.8% on the price paid back then.
These are both in cyclical sectors and look like they’re facing short-term pain. But if we think they have attractive long-term prospects, it makes more sense to me to buy them while they’re down.
Diversification
Buying now does bring short-term risks. And that brings me to a safety measure that I think is especially important at times like this. I’m talking about diversification, and minimising the pain should an individual sector have a tough time.
So, I’d spread my Stocks and Shares ISA investments across different businesses. It can still be stressful in the early days, though. If I had 10 stocks from different sectors in my ISA, I’d consider myself well diversified.
But how can an investor get some early diversification while they’re still building up their pot? I’d always start with a couple of investment trusts.
Investment trusts
I currently own shares in City of London Investment Trust, which invests in a range of UK income shares, and has lifted its annual dividend for more than 50 years in a row. I also hold Scottish Mortgage Investment Trust, which goes for tech growth stocks, primarily on the US Nasdaq index.
If I started today with just those two, I’d have my money spread across a good number of individual stocks, in various sectors, covering income and growth strategies, and with international diversification thrown in.
None of this is meant to be a recommendation, and nobody should buy any shares without doing their own research and assessing the risks themselves. My point is really that, whatever the likely returns from a Stocks and Shares ISA, we can do better in the long term if we buy when sentiment is weak and shares are cheaper. Like now.
