Lump Sum Investing and Regular Investing both have their advantages and disadvantages. On one hand their can be merit in investing a large amount from the start, but there is also logic in regularly investing smaller amounts over a period of time. Perhaps both should have a place in how you invest.
Picture the scene, you’ve done your homework, you know what you want to invest in and you have an amount that you would be comfortable to invest in. Let’s just say that amount you have to invest is £5,000.
Your instincts will probably tell you that if you have confidence in what you are investing in, then its best just to invest it all in one lump sum. So we’ll start there first.
Lump Sum Investing – For the Brave? Or Perhaps the Confident
Immediately taking your £5,000 and buying your chosen investment in one go provides you with the immediate benefit that is likely you will be increasing the chances of capital growth or your profit. This is because investing your full amount at the start of your investing journey will leave your investment exposed to the market longer than to say if you were to regularly ‘drip-feed’ smaller amounts such as £100.
It is also arguably to track the performance of your specific investments; you know the exact price you purchased your shares or funds at from the start, so it makes it easy to compare future performance.
So what’s not to like? Well, let’s just say you purchased £5,000 shares in RBS, only for in two weeks the bank sees its shares fall by 25% because of a significant rise in bad debts announced as part of its interim results. The worry here is that you may have invested in a peak and it could take a long time for the share to recover and ultimately you to turn a profit.
Investing is a mid-long term game but few would be comfortable in large losses on paper shortly after buying an investment. In such a situation, there is more detailed analysis you can do. Fundamental (such as the PEG Ratio) and Technical Analysis (Such as Support and Resistance Levels) can help to limit the scenario described. Understanding the date of the interim results probably would have highlighted the increased risk associated (as shares are particularly volatile following such updates to the market).
Regular Investing and the Joys (potentially) of Pound Cost Averaging
The opposite to investing all your money in a single lump sum is to invest regularly in small amounts. So instead of investing all your £5,000 at once, you decide to invest £500 in your chosen investments every month.
In doing this, the theory is you will benefit from the concept of pound cost averaging. The prices of investments change regularly, but by buying some of your desired investments in regular, smaller monthly intervals you will be smoothing out your purchase price.
In a super simple example, let’s say you regularly invested £100 a month into shares of Company X. In January shares of Company X cost £100 each – so you have 1 share. But let’s say the shares of Company X drop to £50 each in February. You will now have purchased 2 shares and have 3 shares in total! So the only drop in value from your investment is the amount you invested in January. If the shares do eventually recover, theoretically you could up with more shares than if you had invested a lump sum (because buying shares at a lower price due to the dips).
But to every pro there is a con. And the glaring disadvantage here is that let’s just say the shares you invested in experienced exceptionally strong growth from January. You would miss out on some capital growth (due to the delayed month-on-month investment) and you are not guaranteed to buy at lower prices on average as there may be fewer sustained dips in the spare price.
It may sound like a minor point, but your Online Broker may charge you for each time you buy or sell a share (even in your Stocks & Shares ISA). If you are investing a small, regular amount monthly, then the dealing charge per buy can add up and eat away at your potential returns. Most Online Brokers only apply these charges to shares rather than funds.
Who says You can’t do Both?
This can all be a matter of opinion. But if you have faith that a share or fund is seriously undervalued and due to flourish over the coming years, then clearly lump sum investing is a good idea. You will stand to make much more from the appreciation on your original investment as you bought at a lower price. It’s very simple to measure your investment too – has it gone up from the original price? And you will avoid regular dealing charges on buying the same share regularly.
But the markets are risky – whilst they tend to grow in the long-term, in between all that there is general volatility. Regular investing lessens your potential risk should the market move against you and pound cost averaging means you could take advantage of the share price lows. However, this is not guaranteed either and you may end up kicking yourself if your investment goes on a incredibly strong growth trajectory (as you weren’t all in from the start).
There is much debate on the matter and some even suggest that a Lump Sum investment approach is less risky so long as you remain committed for the long-term and could produce better results than if you were to regularly invest smaller amounts. This is because like the housing market, the stock market also tends to rise but with short-term bumps along the way.
So what’s a happy-medium? Perhaps investing a lump sum for investments you have complete confidence in (think those that are undervalued at a moment in time), and balancing that out with regular investing for those investments that you are less confident in or have the time to actively monitor in the short-term.