How to start investing in FTSE AIM shares

The following is not financial advice, and everybody's personal circumstances are different. If you are considering a sizeable investment in small cap shares, it may be best to seek professional advice from a reputable IFA or accountant.

However, for retail investors looking to get started, this guide can be a good starting point.

The  basic investing philosophy can be subdivided into three distinct phases:

Phase One

• Debt - pay off all debt, excluding your mortgage. In this increasingly tight monetary environment, credit cards and loans will cost more than investing returns and reduce your capacity for risk.
• Emergency Fund - you need six months of expenses saved up in an easily accessible account. Equities tend to be worth less when you are more likely to need emergency cash, and the very last thing you want to do is realise a loss to survive a personal financial crisis.

Phase Two

• Calculate your excess annual income
• Some excess income goes into your SIPP - which is almost ridiculously tax efficient for higher and additional rate taxpayers, and especially those eligible for child benefit, 'free' childcare, or universal credit. The downside is that private pensions can only be accessed in your mid-50s, and the government can change the rules at any time
• Target SIPP contributions at blue chip companies, and perhaps a gold ETC. 

Phase Three

• Invest remaining excess income into an ISA, buying shares once again in blue chip companies or index trackers.
• You want to target a 10% annual return on your investment, which is eminently achievable within high yield dividend stocks or perhaps the S&P 500.
• Compound until you reach £6,000, or £12,000 depending on what is realistically achievable.
• A £6,000 portfolio with a 10% return should yield £50 per month (£100pm for a £12,000 portfolio). You can then invest this cash into small caps.
• This creates a solid financial base from which to experiment with higher risk opportunities. We consider that a small cap portfolio should hold at least 10 shares for diversification purposes.

For UK residents who have yet to purchase a first home, the Lifetime ISA is a very important option to consider.  You can save up to £4,000 per year in a LISA, which is then topped up by 25% by the government, up to £1,000 per year until you turn 50. 

If you invest the full £4,000 allowance, this leaves you with £16,000 to invest in other ISA accounts. The money must be used to buy your first home, or it can be withdrawn at the age of 60. You must be over 18 and under 40 to open a LISA. You can invest in cash or shares as usual. Early withdrawals come with a penalty charge. 

Our view is that starting with smaller amounts, or even a demo account at first, can be very valuable for novice investors looking to get started in the AIM space. But once you get up to scratch, AIM shares have little analyst coverage, and so there are often exceptional opportunities for those with the skill and inclination to hunt them down.

Diversification is critical: high risk companies can and do fail, so going 'all in' on one asset is rarely a good idea. At best, you may struggle with a good night's sleep.

Caveat Emptor

l rarely trade on leverage, instead preferring to buy deep value small cap stocks within an ISA to benefit from huge tax-free capital appreciation.

Currently, all UK investors have a £60k SIPP annual allowance and a £20k ISA annual allowance. 

As ISA contributions are made from net income, you need to make circa £100k of gross income per year to max out your tax shelters, and that's before even considering living expenses.

In my view, it only makes sense to start trading on leverage once you are earning over £150k per annum.

Trading on leverage means forgoing the tax benefits of a SIPP or an ISA, and then paying Capital Gains Tax on any returns. Further, 75% of typical retail CFD accounts lose money.

And even if you do make a profit, EIS investments deliver better returns if you are prepared to do the research.

Of course, highly skilled traders can make huge sums of money using leverage. But in reality, this is a very small number of dedicated professionals.

And as there's almost always another retail trader on the other side of leveraged trade, their income is derived from the losses of amateurs.