Early in the new tax year is a good time to review your financial plans and think about saving a bit 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. Here we explore the two different options, so you can decide which best suits you.
Considerations
The first step is to establish how much you can, or should, invest.
Before considering investing a lump sum, you need to ensure you have enough cash in the bank. This should cover at least three to six months of essential expenses, or even more if you are self-employed.
You should also avoid investing any money you are going to need in the next five years. While investment values tend increase in the long term, they do fluctuate in the short term. An investment period of less than five years means that you could lose money, as there is less time to smooth out volatility.
If you have more capital than you need for your immediate requirements, you may want to consider investing a lump sum. On the other hand, if you are just starting to think about investing, monthly savings will probably be more suitable. Starting to save regularly is a great way of building good financial habits, but you still need to make sure you are keeping enough cash aside, or building up an emergency fund as income allows.
Interest and inflation
Interest rates are currently at their lowest ever. If you are receiving interest on your cash savings, the rate is likely to be poor. There are still good reasons for holding some cash (for example, keeping an emergency fund), but holding large amounts of cash for long periods could leave you worse off financially.
The cost of living rises over time, often at an average rate of 2 to 3% per year. If you are not receiving this amount in interest, you are actually losing money in real terms, as your capital will not have the same spending power in the future.
If you want your money to keep pace with inflation, investing the money at the earliest opportunity will be your best option.
Market timing
Of course, it is difficult to know when to invest. The market constantly goes up and down, and the news about the world economy can be hard to keep up with.
The objective of investing is buying low and selling high. The problem is when the market is down, people can be wary about investing money and, when it is high, it is easy to believe the rising trend will continue – which is not always the case in the short term. However, statistics do show that over the long term, investment values do generally rise.
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 for.
When saving monthly, you do not need to worry about market timing - you are only investing relatively small amounts and will capture both high and low points.
Pound cost averaging
Regular investments benefit from pound cost averaging. This means that you can gain from both high and low points in the market.
When prices go up, your existing investments increase in value and, when prices go down, shares become cheaper, meaning you can buy more for your money.
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, the market fluctuates daily. Monthly investors are better placed to smooth out this volatility.
A compromise could be to invest your lump sum in stages, for example over six months or a year. This will give you some of the benefits of pound cost averaging, without keeping excessive amounts of cash for too long.
Managing risk
Whether you are investing a lump sum or a monthly amount, you will need to consider the risk level 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 even 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 30-year career ahead of them can probably invest in riskier assets than a retired person who is relying on their capital to provide them with an income.
Rather than researching and trading shares daily, 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 either. 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 still diversify your portfolio.
Conclusion
It is often not a straightforward choice between regular or lump sum investing. The best option for your individual case will depend on:
- Whether your investment is coming from capital or income
- Your investment timescale
- The amount you have to invest
- How you feel about investments and risk, including how well you understand financial markets.
Monthly investing may be for you if:
- You are already making regular savings from income
- You want to build discipline and good financial habits
- You do not have a lump sum to invest
- You would prefer not to invest a large sum in one transaction.
- You can invest for the long term
Investing a lump sum could be the best option if:
- You have surplus cash on deposit receiving a poor rate of interest
- You are a confident and experienced investor and can accept fluctuations in value
- You are reliant on the fund to provide you with an income.
Either way, getting professional, unbiased advice is essential. Working with us to agree a suitable investment risk profile and tax strategy will ensure ‘peace of mind’ and increase the chances of achieving those longer term goals.