How to invest when you are on a low income

If you are on a low income, can you still invest? How viable is it?

Article updated: 24 October 2019 7:00am Author: Michael Baxter

Investing is for the rich, right? Not necessarily. If you can set aside a proportion of your monthly income every month, even if it is quite small, over time it can pay off significantly. But be warned, investing is not a way to get rich quick, you need to give it time, and there are no guarantees. It’s fun though and can be educational. 

The key to investing, if you are on a low income, is being able to set aside an amount every month and being very patient.

And I need to start with a harsh reality of the 21st century. If you are below 40, you probably won’t retire this side of 70. I would not even be surprised if the retirement age goes up to 80, at some point in the next few decades. That means, even for people approaching 40, there could be another 40 years of work ahead.

If you can set aside a proportion of your income each month, even if it is just 10% or even 5% of your net income, and invest if appropriate, then during your working life, the rewards should be good.

But there are no short cuts, you need to follow certain rules.

Make sure the investment portfolio you create is diversified and give it plenty of time. 

There are three factors at play that come to your aid.

Firstly, there is the ISA. This is a generic name given to a government scheme, regulated by HMRC, which provides a tax-efficient wrapper around cash and investments. ISAs can come in many different shapes and sizes, some involving investing in cash, others in equites, and others on various investment vehicles. You can invest up to £20,000 a year into an ISA, which is probably not an option if you are on a low income, but you can invest as little as you like. There are certain rules concerning ISAs and you need to invest into an ISA via an approved scheme.

Secondly, there is an ISA scheme called a Lifetime ISA, or LISA — under this scheme, the government tops up any investment you make in any one year by 25 per cent. So, if you were to invest £1,000 in one tax year into a LISA, the government will throw in another £250. The annual limits on a LISA are much lower than on an ISA.
There are catches, you cannot cash in a LISA before you are 60, unless you use the money for a deposit on a house and you must be under 40 to open a LISA, and you cannot contribute to the LISA once you turn 50.

The third benefit is the compounding effect of money you invest in shares over time. There are no guarantees, of course, shares can go up and down in value. But looking at history, over a long-term time horizon, a diversified portfolio mainly invested in shares, should have increased in value. If you take the FTSE 100 since it was founded back in 1984, after taking into account dividends, and factoring in inflation, a portfolio of investments that tracks the FTSE 100 has risen by an average of around five per cent a year. Or so I have previously calculated — to reiterate, that is after inflation and includes dividends, and is over a long-time frame.

A growth of five per cent a year means an investment doubles in value every 15 to 16 years.

So, think about that. If you were to invest £1,000, assuming five per cent a year growth, that would be worth £2,000 after 15 to 16 years. If you invested £1,000 a year for ten years, then stopped investing, then, assuming you invested in a LISA with the government chipping in, subject of course to all the rules regarding a LISA, twenty years from the start date, that £10,000 you invested would be worth around £22,000. After 30 years, it would be worth around £36,000. Charges would come off the returns, of course, but these figures are approximates anyway.

Just to reiterate, there are no guarantees here, investing is not certain.

But this becomes especially powerful if you continue to invest every year.

Let’s say you set aside 10 per cent of your monthly net income. I calculate, assuming a return of five per cent a year, and before charges, that within 30 years, assuming you have passed 60, and you invested in a LISA, you would have a lump sum equating to around eight times your annual net income.

After forty years, the sum would be roughly 15 times your annual income.

There are conditions, of course. Follow the principles of diversification, follow the rules of a LISA, and don’t tie yourself to a specific target date. If you are targeting a sum of money, which you may want to liquidate, then wait until you have reached that target. If you set yourself a specific date, say 31st December 2050, you might be unlucky and stock markets might have crashed that month. If you set yourself a target, say ten times annual income, then you are less vulnerable to short-term market volatility since you sell when the timing is right.

No guarantees of course, I merely report what has happened in the past, the future is a strange place.

These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Michael Baxter portrait photo
Michael Baxter

Economics Commentator

Michael is an economics, investment and technology writer, known for his entertaining style. He has previously been a full-time investor, founder of a technology company which was floated on the NASDAQ, and a director of a PR company specialising in IT.