Lump sum vs regular contributions
This content is for information purposes only and should not be taken as financial advice. Every effort has been made to ensure the information is correct and up-to-date at the time of writing. For personalised and regulated advice regarding your situation, please consult an independent financial adviser here at Castlegate in Grantham, Lincolnshire or other local offices.
As an investor, one of the biggest questions you may face is how to invest a pot of money (e.g. from an inheritance windfall). Should you invest it all at once, as a lump sum, or should you “drip feed” it into a portfolio – i.e. “pound cost averaging?” Below, our Grantham financial advisers at Castlegate lay out some of the main pros and cons for each approach. To discuss your own family financial plan with us, please get in touch to arrange a no-obligation financial consultation, at our expense:
01476 855 585
info@casfin.co.uk
Investing a lump sum
Suppose you are given a large bonus or receive a significant cash amount from selling your share in a business (e.g. £30,000). One of the main benefits of investing a lump sum into a pension – or another investment “vehicle” which locks the money away for a specific purpose, like a Lifetime ISA – is that it mitigates the temptation to spend it all at once. Some people find it very difficult to be disciplined about keeping large sums in easy-access savings. By putting it into a separate investment account, it may be easier to keep it “out of sight and out of mind”.
Investing a lump sum can also help the investor avoid missing out on the “opportunity costs” which may be incurred by keeping lots of money in easy-access savings. The latter may offer lower returns (largely represented by the interest rate) compared to investing in other assets, particularly equities. By deploying the full capital right away, the investor can harness the potential of the market and possibly generate a higher overall return.
However, this may not always transpire. Indeed, investing a lump sum could be particularly painful for an investor if the market crashes shortly after committing the full capital. If the investor then withdraws the capital, perhaps out of panic, then these “paper losses” could become crystallised losses. For this reason, investors should consider financial advice before making a big investment decision so they can better account for their personal profile, asking themselves the right questions. For instance, if you invested a lump sum and your portfolio crashed by 20% the next day, how would you react?
Investing gradually
The advantage of this approach is that it can mitigate the aforementioned drawback of investing a lump sum. Suppose you invest £30,000 over a 24-month period instead of all at once. If the market crashes during that period, it is less likely that you will experience a “paper loss” on the full amount. For example, if the market crashes in the second month but recovers by the sixth month, then this can be more psychologically manageable for many investors.
Many investors may even regard this four-month period (between months two and six) as an opportunity to buy investments “on the cheap”. Perhaps certain shares fall close to – or below – their “fair value” and later rise back to the higher prices that investors were previously willing to pay (or possibly rise even beyond). Another possible benefit of gradual investing is that it helps to foster a habit of investing. Forming investor discipline is a valuable life skill which helps people to build up their net worth over time.
The downside of gradual investing (as mentioned) is that you could incur an opportunity cost if you keep too much money in low-interest cash savings.
Ideas to help investors
A range of factors come into play when an investor is considering whether to invest a lump sum all at once or gradually. Talking through your options with a financial adviser will help you arrive at the most informed decision. However, we can provide some general ideas below which you may want to bring into this conversation.
One consideration is your tax position. Retaining a large sum in cash (as you “drip-feed” your money into a portfolio) could generate a lot of interest. In itself, this would be welcome to many people, but be careful to think about your Personal Savings Allowance (PSA). In 2023-24, a basic rate taxpayer can earn up to £1,000 from interest, tax-free, each financial year. For someone on the higher rate, the threshold is £500.
With savings rates now available at 5% or even higher, more and more people are inadvertently breaching their PSA with their cash savings. Therefore, consider how to construct your savings in a tax-efficient way. Some options include Premium Bonds, Cash ISAs and directly-held UK government bonds which can allow tax-free cash prizes, interest and capital gains, respectively.
It is also wise to check your wider financial plan before investing a large sum of money – whether gradually or all at once. For instance, does your emergency fund need a boost? Are there any high-interest debts which need clearing? If you are considering your estate plan, could any of the money be used in a tax-efficient way to help your loved ones – e.g. making lifetime gifts within your Annual Exemption?
Invitation
If you are interested in discussing your own financial plan or investment strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense:
01476 855 585
info@casfin.co.uk
