Should you invest a lump sum or drip feed money into the markets?

2 mins. to read
Should you invest a lump sum or drip feed money into the markets?

How you invest can have just as big an impact on your returns as where you invest, especially if you have a long-term investment horizon.

Younger investors who are saving for their retirement in a pension or ISA have two main options. They can either invest a regular amount each month out of their salary or save up their money and then make occasional lump sum investments as and when they can afford it.

Those who pay into a company pension scheme would normally fall into the first of these categories. You can also set up a regular investment service if you have an ISA or Self-Invested Personal Pension (SIPP) with a broker. These allow you to automatically invest the same amount each month in different shares or funds at a reduced rate of commission.

The main advantage of regular investing is that it benefits from pound cost averaging. Drip feeding money into a particular share or fund evens out the ups and downs in the purchase price and eliminates the risk of putting all your money in just before a market correction.

Despite the advantages, pound cost averaging doesn’t necessarily guarantee better returns.

It also imposes a more disciplined approach and removes the temptation to try to time the market. This is important because the price you pay for an investment is one of the key factors that determines your final return. Of course we all like to think we know when to invest, but if you’re impulsive about it, a regular investment scheme would be the sensible option.

Despite the advantages, pound cost averaging doesn’t necessarily guarantee better returns as it all depends on the subsequent price movements. If you drip feed money into a share that enters a long-term uptrend it would actually work out better to have put all your money in upfront, although you wouldn’t have known that in advance.

Lessons from history

There have been some interesting studies that compare the results of lump sum investing to regular investing. A good example is the work done by Vanguard in 2012 that looked at the historical monthly returns for £1 million invested as a lump sum and through regular investment schemes over periods as short as 6 months and as long as 36 months, assuming that the money was kept in cash before being invested.

The authors tested various stock/bond allocations over rolling 10-year periods from 1926-2011. They found that the lump-sum method beat a 12-month regular investment scheme about two-thirds of the time, regardless of the underlying stock/bond portfolio. Longer regular investment schemes had even less chance of outperforming.

The reason for the surprising conclusion was that they were comparing the performance of a lump sum investment at the start of the period to regular investments made over a subsequent period of time. As markets normally go up, the delay in the investment meant that they missed out on the initial potential gains that would have then compounded over time.

In reality, most people who are saving up for their retirement have yet to accumulate a lump sum and so the regular investment method offers the quickest way that they can get money into the markets. This would be likely to outperform a series of delayed lump sum investments unless the markets fall consistently over the investment timeframe.

Comments (1)

  • John Day says:

    The Vanguard paper shows that 2 out of 3 times the Lump Sum approach produces a better return that dollar cost averaging. I think it is worth noting the neglible extent of this out performance. According to the Vanguard paper $1m results in $2.396m over 10 year for the drip feed approach (annual return 9.13%) where as the lump sum approach results in $2.450m over ten years (annual return 9.38%). So the out performance over ten years is $54k on a $2.4m portfolio. Now if you really had $1m to invest in stocks and that was a significant proportion of your wealth, what would you do?

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