I recently opened a Junior SIPP for my daughter, who is still in primary school. To start with, I’ve just put £250 in it, but will look to add bits and bobs whenever I have the money.
But where should I invest this sum right now? The FTSE 100 or S&P 500? Or perhaps an individual stock?
US indexes look frothy
The first thing I want to mention is the strategy I intend to use here. Because I want my daughter to have a nice nest egg one day, I’m not going to take excessive risks.
In other words, there will be no penny stocks or risky small-cap shares. Instead, the core of the portfolio will be in index funds, ETFs, and investment trusts. Any stocks will be established blue chips with significant competitive advantages.
Unfortunately though, the market looks a little hot right, especially across the pond. Earlier this month, Bank of America warned that eight valuation metrics for the S&P 500 now exceeded levels seen during the dot-com bubble.
Meanwhile, the tech-heavy Nasdaq-100 index is near record levels, driven skywards by surging semiconductor stocks. And it now has a sky-high price-to-earnings (P/E) ratio of 43, according to BlackRock.
Therefore, I’m wary about investing in these US indexes while they’re at nosebleed levels. I would prefer to invest in them when they’ve pulled back significantly.
Meanwhile, a favourite of mine from the FTSE 100 — Scottish Mortgage Investment Trust — also hit a record high recently. This was driven by its massive position in SpaceX, which looks ridiculously overvalued to me but cannot be trimmed by the trust yet.
This adds a fair bit of near-term risk, making me wary about buying Scottish Mortgage shares today. I would prefer to add this FTSE 100 trust to the SIPP after one of its semi-regular meltdowns.
Dividend ETF
However, one potential investment that has caught my eye is iShares UK Dividend ETF (LSE:IUKD).
This appeals to me for a number of reasons. First, it holds 50 profitable UK stocks from across the FTSE 100 and FTSE 250. These are established blue chips like Legal & General, HSBC, Rio Tinto, Admiral, and Lloyds. So there’s a lot of diversification here, which reduces risk.
Also, the ETF is invested in the highest-yielding shares from both indexes, excluding investment trusts. Therefore, my daughter’s SIPP should receive a steady flow of dividends, with an attractive starting yield of about 4.5%.
On top of this, we have a much more sensible P/E multiple of 15.3. Combined with the dividend yield, there appears to be much more value on offer here compared to the S&P 500 or Nasdaq-100.
The main risk is that the ETF only holds UK stocks, and these may well fall out of favour for periods of time. A black swan event could also disrupt dividends, at least temporarily.
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Compounding should do the heavy lifting
That said, the fact there are 50 stocks reduces risk somewhat. And over the long run, I think this ETF could help the SIPP achieve an 8% return (alongside other stocks).
If so, then the portfolio will grow to more than £400,000 after six decades, assuming I contribute another £500 per year for the first decade, while also picking up and investing tax relief.
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Ben McPoland owns shares in HSBC, Legal & General, and Scottish Mortgage.
