Lump sum or monthly investing?

Which is best for my returns: lump sum or regular monthly investing?

As we start the new tax year, a fresh set of annual contributions kicks in for savings wrappers. For the ISA, this is a £20,000 annual allowance; for pensions – following recent increases in Chancellor Jeremy Hunt’s Spring Statement – it’s £60,000.

How we approach contributions, will depend largely on circumstances. Those more financially fortunate may have cash waiting in the wings – from savings, a windfall from work or sale of an asset, or indeed, as is common, an inheritance. Many of us will have a savings habit too, putting a slice of our salaries away each month for a rainy day.

It gives us some options as we start the new tax year: we could use up our allowance quickly and put as much money into the market as we can afford via a single lump sum, or we could devise a monthly savings plan and drip-feed cash into our chosen investments, such as Alliance Trust, on a regular basis.

But, looking at the maths, which is actually best for our returns?

Lump sum vs monthly investing

Compound interest – Albert Einstein described it as the eighth wonder of the world, and it’s certainly a humbling force. It is the reason why lump sums can return considerably more than monthly investing – our cash is simply spending more time in the market, earning returns upon returns. As the saying goes: it’s time in the market, not timing the market.

But different approaches will yield different results. Stockbroker AJ Bell has run the numbers on a couple of scenarios.

In the first, it compares a single lump sum of £20,000 invested 20 years ago in the Investment Association’s Global Equity index, against 240 monthly instalments of £83.33 over the same period. Given that a much larger amount of money is in the market for longer, the lump sum wins hands down – returning £118,570 over 20 years vs £51,360 for the monthly approach.¹

In the second scenario, £12,000 is invested once a year for 20 years in the IA Global Equity index, vs 12 monthly instalments of £1,000 for 20 years. Variations between results are significantly smaller than in the first scenario. According to AJ Bell’s figures, the annual approach returns £644,853 over 20 years, whereas the monthly approach generates £616,315.¹

While in both scenarios the lump sum returns are higher, there are some benefits to taking a monthly approach.

Gently does it

The first benefit is that it’s a smoother ride. Because money is going into the market more gradually, swings in the value of your investments are likely to be less extreme. In the first of our scenarios, there were times when the lump sum fell 34%, whereas the maximum the portfolio using the monthly approach fell was 24%. In our second scenario, the biggest fall by the lump sum approach was 31.5%, vs 23.7% for the monthly approach.

The second benefit, is in reducing anxiety about market timing. It’s natural to feel concerned that the moment we choose to invest will be the worst possible time to do so, and that in the days or weeks that follow, a big market crash will come along and pummel our investments with nasty losses. Regular investing sidesteps these worries. What’s more, share dealing services often offer cheaper dealing fees for monthly investing, in comparison to one-off trades.

The final benefit is pragmatism – most of us won’t have piles of cash waiting to be invested, and find it easier to chip away at financial goals by using affordable portions of our monthly salaries.

Alliance Trust

Whether you are considering lump sum or monthly amounts, Alliance Trust has been investing in shares across global markets for generations of investors since 1888, aiming to provide both income and capital growth. It is why Alliance Trust considers itself a core to any investor’s portfolio.

Marcus De Silva, Freelance Investment Writer

1. AJ Bell, Morningstar, 21 March 2023

This information is for informational purposes only and should not be considered investment advice. Past performance is not a reliable indicator of future returns. The views expressed are the opinion of the Manager and are not intended as a forecast, a guarantee of future results, investment recommendations or an offer to buy or sell any securities. The views expressed were current as at April 2023 and are subject to change. Past performance is not indicative of future results. A company’s fundamentals or earnings growth is no guarantee that its share price will increase. You should not assume that any investment is or will be profitable. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

TWIM is the authorised Alternative Investment Fund Manager of Alliance Trust PLC. TWIM is authorised and regulated by the Financial Conduct Authority. Alliance Trust PLC is listed on the London Stock Exchange and is registered in Scotland No SC1731. Registered office: River Court, 5 West Victoria Dock Road, Dundee DD1 3JT. Alliance Trust PLC is not authorised and regulated by the Financial Conduct Authority and gives no financial or investment advice.