Angela asks: “Assuming I had the total amount ready to invest, what are your thoughts on the best strategy for it? Do I invest the full amount at once at the beginning of the tax year or invest in 12 equal amounts throughout the year?”

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Q&A 65 – Lump Sum Or Drip Feed Investing – Shownotes

Angela asks:

Assuming I had the total amount ready to invest in my S&S ISA, what are your thoughts on the best strategy for it?

1. Do I invest the full amount (£15,240) at once at the beginning of the tax year in order to get full benefit from potential interest gains, or do I
2. Invest 12 equal amounts (£1,270) on a monthly basis throughout the year to take advantage of cost averaging?

Great question Angela.

The technique you are referring to is dollar-cost or pound-cost averaging. The dollar-cost averaging section of our complete guide to investing looks at this in more detail.

However, this is an interesting subject so I’ll run through a summary now in response to your question.

 

Dollar Cost Averaging – An Example

Let’s use an example with easy maths. Say you have £12,000 to invest today, but you are a little concerned about short-term variance.

• Scenario 1: You invest £12,000 today
• Scenario 2: You invest 1,000 every month

Let’s say between January and September, the market fell 1% every month, and in the final 4 months, it increased by 2.5% each month.

• Scenario 1: £12,222
• Scenario 2: £12,699

However, if the opposite occurred (8 months of 1% increase followed by 4 months of 2.5% decrease):

• Scenario 1: £11,743
• Scenario 2: £11,576

Effectively, if the market falls over the period of new investing, you’ll be better off dollar-cost averaging, but if the market increases, you’ll be better off investing all at once at the start.

 

Trying To Time The Market

The problem is that we cannot predict what the market will do and hence we shouldn’t try to time the market.

Therefore, mathematically, the market goes up from bottom left to top right and hence investing all at once at the start of the year will be better. Additionally, by investing all up-front you also benefit more from dividend distributions as well as capital growth.

However, on the other hand, dollar-cost averaging reduces the variance in your results and therefore may be better if results in the “short-term” matter. By short-term here, we are referring to between 3 and 8 years, which would be a reasonable time to handle some of the variance in stock markets, but maybe not take the whole hit.

For example, if you invested your full lump sum on December 31, 1999, you’d certainly have wished a few years later that you dollar cost averaged.

 

 

Lump Sum or Drip Feed Investing – Example

My overarching advice would be that, unless you are investing a very large proportion of your net worth in one investment, then you shouldn’t need to dollar-cost average. And, if you are investing a very large proportion of your net worth in one investment, then you may want to revisit our investing guide and the Q&A podcast related to diversification.

As I say, I’ve written much more about this, with several examples and looking at variances and standard deviations and all those geeky things in our investing guide.

Hope that helps.

 

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