I had aclient ask this question recently and it is an interesting topic. Choosing to invest is the most important decision, but once you’ve made that choice you’ve got to choose how and when. Ihave linked to agreat calculator at the end, so readon.
Obviously, you can only invest alump sum if you have the money now. Most people earn money over time, and therefore must stick to amonthly investment schedule, that’s fine. However, if you can make alump sum, it is worth exploring the option.
Maximise time in the market
Making alump sum investment is the most effective way to invest. This is because it maximises ‘time in the market’. If you have money that you want to invest, alump sum investment is the only way to get all your money working now. If markets go up then you benefit fully, but if markets go down then all that money invested is affected by the market fall.
Timing the market fails
Some people try to ‘time the market’: they wait until they think markets are going to rise and then they invest. This doesn’t work. The evidence tells us that investors cannot know when markets are set to rise, nor can commentators, it isn’t worth trying. ‘Market timers’ could spend years waiting on the sidelines and miss out on investment growth and the benefits of compound interest.
The monthly approach
Others try to hedge their bets. They accept they don’t know if markets are going up or down. But they don’t like the idea of the money they invest being fully affected by amarket fall. So, they invest monthly. Let’s say that over the course of ayear they end up investing the same amount, but they spread it evenly across 12 months.
The example investor
Imagine an example investor with £12,000. They are trying to decide if they should invest alump sum or invest monthly, £1,000 at atime. Whatever decision they make now they are then going to replicate each year going forward.
I have compared how much money they would have at the end of the year by investing in alump sum or monthly. The following assumptions apply:
The Outcome
Approach End of Year 1 End of Year 5 End of Year 10 End of Year20
Lump Sum £12,867 £86,336 £191,718 £552,889
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Monthly £12,465 £72,010 £174,094 £523,965
£ Gap £402 £14,326 £17,624 £28,924
% Gap 3.2% 19.9% 10.1% 5.5%
As time goes on the gap continues to widen. There are interesting quirks here, while it becomes relatively less important whether you invest as alump sum or annually, the cumulative difference continues to grow. And that cumulative difference isstark!
If you invest while the market is falling, you may be worse off if you invested alump sum. However, as an investor you need to be comfortable with the ups and downs of the market and should be investing for the long-term.
Approach End of Year1
Lump Sum £11,186
Monthly £11,662
£ Gap -£476
% Gap ‑4.3%
Conclusion
Clearly there are shortcomings in this calculation. Markets don’t just increase endlessly in astraight-line, they go up and down, and change from day-to-day. However, overall, we expect an above inflation performance over the long term in our investments. The short term is unknowable, so we rely on our long-term expectations and invest.
Here is afun calculator Ifound so you can do your own calculations.
Taking it further
Vanguard has agreat research paper on the effectiveness of lump sums versus monthly contributions in real market conditions. This strongly supports the conclusion that lump sum investing works better in about 2out of 3scenarios. Ihave linked thisbelow.
*Investments carry risk. The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not areliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circ*mstances.
