Invest a lump sum or save regularly?
Regular investments could prove more beneficial than a lump sum.
So, you’ve figured out what you want your money to do, how long you want to invest for and how much you can afford to invest, but how you actually pay money into your investments could have a significant impact on the returns you receive.
The two main ways of investing your money is either as a lump sum (all of your savings are invested immediately) or through regular investment (typically through monthly contributions).
How you invest might depend on your circumstances and the affordability of investment, but also your attitude to risk.
If, for example, you’re comfortable with risk and have conviction in your choices of investment, you may want to invest a lump sum.
However, if you don’t have enough put aside (most investment funds, for example, have a minimum lump sum investment of £1,000) or are cautious about piling everything in, you might prefer to drip feed your money on a regular basis.
Lump sum or regular - which is best?
Say you have £10,000 to invest. If you invest all of it straight into the stock market, your full amount of capital has the greatest potential for growth, as it’s immediately fully exposed to the market. The assets within which you invest, be it shares, bonds or units (in a unit trust), are bought at the same price and you can benefit from any price increases straight away.
If you drip feed your £10,000 investment on a regular basis, only some of your money will be earning investment returns in the early months and you won’t get the access to the total growth you would if you were fully invested.
The potential downside of this is that you’re exposed to potential downward fluctuations in the market. So, if you invested all of your money in the FTSE 100 (the stock market index that tracks share performance of the top 100 companies in the UK), for example, and it dropped by 20%, your investment would follow suit.
Staying invested in the stock market over a long period gives you the opportunity for your money to recover – but this could take a long time and requires a lot of nerve and patience on your part as an investor.
You also have to think about market timing – are you investing at a peak or at a low? This can be hard for even professional investors to judge.
A way to steer around the fluctuations in price of markets or assets is to invest on a regular basis. This is technically known as ‘pound cost averaging.’
Pound cost averaging explained...
This is the process of regularly investing the same amount, usually on a monthly basis, to smooth out the highs and lows of the market within which you’re invested. It’s also extremely useful as a means of tipping your toe in the water and monitoring your investments on a monthly basis if you’re a beginner or simply don’t have an up front lump sum to invest.
The effect of pound cost averaging is that you’re buying assets at different prices on a regular basis, rather than buying at just one price, and while riding out the movements of the market, you could also end up better off than if you invested with a lump sum. Let’s look at this in practice. If you invested a £10,000 lump sum and bought shares valued at £10 each, you’d have 1,000 shares. Now, if you bought £500 worth of shares per month over 18 months (amounting to £10,000 overall all), you would buy 50 shares in the first month.
But if the share price went down to £9.50 in the second month, you’d be able to buy 52 shares, as the shares are at a lower price. Therefore, rather than your full £10,000 investment being affected by the drop in share price, only a small proportion of your money drops in value. After 18 months of movement in the share price, it might end back on £10.
If you invested with a lump sum, you’d still have the same amount of money and the same number of shares, but, by regularly investing, you may end up with more shares and, consequently, some growth of your capital, despite the share price ending up the same as when you invested and investing the same amount.
However, it’s important to remember that you may not necessarily benefit this way using pound cost averaging. One potential downside of this is that if your investments continuously grow, you’ll be missing out on some of that growth as not all of your money has been invested over the whole period.
In fact, data from the Association of Investment Companies (AIC) shows that over the very long term (20 years), a lump sum investment of £12,000 has returned £86,000, while a £50 a month investment over the same period has returned £31,000. but if you’re nervous about the markets, or in a particularly volatile market, regular investment can help smooth out the market risk.
Combining the two...
If you’re confident in investing a lump sum in a particular asset or market, you could split some of your money between a full investment and regular contributions. If you decide to do this, make sure that the money you are holding back for regular investments is working as hard as possible for you in the mean time by keeping it a high-interest savings account that allows you to make regular withdrawals.