The new tax year provides a good opportunity to review your financial affairs and think about whether you need to save more for the future.
If you are thinking about topping up your ISA or pension, you can either invest a lump sum now, or make regular contributions over the course of the tax year. This guide explores the options, so you can decide which method best suits you.
The first step is to establish how much you can, or should, invest.
Before considering investing, it is crucial to hold a sufficient amount in cash which can be accessed immediately. Ideally, this should cover between three to six months’ worth of essential expenditure. If you are self-employed, this may need to be more.
You should also avoid investing any money that you will need to use within the next three to five years. Whilst investments usually see growth over the long-term, they can fluctuate heavily over the short-term. Therefore, should you invest for a period of less than five years, this could result in losses as you may be forced to withdraw your investments before volatility has decreased.
If you have more capital than you need for your immediate requirements, you may want to consider investing a lump sum.
If you are just starting to think about investing, or if you do not have a large capital reserve, monthly savings will probably be more suitable. It should be noted that you will still need to maintain an emergency fund of easily accessible cash.
Budgeting can help identify how much you can afford to invest each month. Saving monthly is a great way to start sound financial habits.
Interest and Inflation
Whilst interest rates are on the rise, they are still the lowest they have ever been. This means that interest received on your cash savings is likely to be poor in comparison with alternative investment opportunities. Whilst you need to keep some easily accessible cash back for emergencies, holding too much for long periods could leave you worse off financially.
The cost of living rises over time, often at an average rate of 2-3% per year. This means that if the interest rate on your cash savings falls short of this figure, you are losing money in real terms, as your capital won’t have the same spending power.
Investing at the earliest opportunity will give you the best chance of your money keeping pace with, and exceeding inflation.
Timing the Market
Of course, it is difficult to know when to invest as the market goes up and down throughout the day.
The ideal situation would be to buy low and sell high. The problem is when the market is down, people can be nervous about investing more money. When it is high, it is easy to believe the rising trend will continue.
There is no secret to timing the market. Statistics show that over the long term, prices do generally rise. Therefore, investing a lump sum successfully depends less on when you invest, and more on the assets you have selected and how long you hold them.
On the other hand, saving monthly has the bonus that you do not need to time the market as you are only investing small amounts and you will capture both high and low points.
Pound Cost Averaging
Regular investments benefit from pound cost averaging. This effectively means that you gain from both high and low points in the market.
When prices go up, your existing investments increase in value. When prices drop, shares become cheaper so you can buy more.
In a consistently rising market, investing a lump sum will give you the best returns, as it has longer to grow. However, even in a strong economy, markets fluctuate daily, and so monthly investors have the advantage of smoothing out the volatility.
A compromise could be to invest your lump sum in stages, for example over six months or a couple of years. This will give you some of the benefits of pound cost averaging, without keeping excessive amounts of cash for too long.
Whether you are investing a lump sum or a monthly amount, you will need to consider the level of risk of your investment.
Investments vary in terms of risk, from cash (low risk and low return) to equities (high risk and high potential return). There is also variation within each asset class, as the shares of an established UK company are likely to behave differently from a start-up in an emerging market.
A younger investor with a long career ahead of them could invest in riskier assets than a retired person who is relying on their capital to provide an income.
Rather than researching and trading shares on a daily basis, it is simpler, and usually more profitable, to invest in a diversified portfolio which holds a wide variety of different assets.
You do not need to have large amounts of capital to benefit from this. A multi-asset fund can provide all the diversification you need, at a reasonable cost and with low minimum contributions. Even if you are investing monthly, you can diversify your portfolio from day one.
It is often not a straightforward choice between monthly or lump sum investing. The best option will depend on:
- Whether your investment is coming from capital or income
- Your investment timescale
- The amount you have to invest
- Your attitude to risk
- Your experience with investments and your understanding of the financial markets
Monthly investing may be for you if:
- You are making regular savings from income
- You want to build good financial habits
- You don’t have a lump sum to invest
- You would prefer not to invest a large sum in one transaction
Investing a lump sum could be the best option if:
- You have surplus cash on deposit receiving a poor rate of interest
- You can accept fluctuations in value
- You are reliant on the fund to provide you with an income
Please don’t hesitate to contact a member of the team to find out more about your investment options