Should I invest a lump sum?
This might seem like a purely practical consideration – but it can have a big impact on your returns
Your decisions will invariably depend on your circumstances, but you should also consider your attitude to risk and think about where you are investing your money and why.
If, for example, you're comfortable with the risks and have a strong conviction in your choices, you may want to invest a lump sum.
However, if you don't have a lump sum, or if you're cautious about going all in, you might prefer to adopt a regular savings strategy.
Find out more: Understanding investment risk – this guide explores the risks you face when investing
How do I invest a lump sum?
Say you have £10,000 to invest. If you invest all of it straight into the stock market, your capital has the greatest potential for growth, as it’s immediately fully exposed to the market.
The assets in which you invest, be they shares, bonds or units in a fund such as a unit trust, are bought at the same price and you can benefit from any price increases straight away.
The potential downside of investing a lump sum is that you’re exposed to potential downward movements in the market. So, if you invested all of your money in the FTSE 100 (the stock market index that tracks share performance of the top 100 companies in the UK), for example, and it dropped by 20%, your investment would follow suit.
Staying invested in the stock market over a long period gives you the opportunity for your money to recover – but this could take a long time and would require a lot of nerve and patience on your part as an investor.
You also have to think about market timing – are you investing at a peak or at a low? This can be hard for even professional investors to judge.
Find out more: How to invest – discover the right mix of investments for you
Regular savings and 'pound cost averaging'
Regular savings offers the opportunity to make market fluctuations work in your favour. The strategy involved is known as ‘pound cost averaging.’
Pound cost averaging describes the process of regularly investing the same amount, usually on a monthly basis, to smooth out the impact of the highs and lows of the price of your chosen investment.
The effect of pound cost averaging is that you're buying assets at different prices on a regular basis, rather than buying at just one price. And while riding out the movements of the market, you could also end up better off than if you invested with a lump sum.
Let’s look at this in practice. If you invested a £10,000 lump sum and bought shares valued at £10 each, you'd have 1,000 shares. Now, if you bought £500 worth of shares per month over 20 months (amounting to £10,000 overall), you would buy 50 shares in the first month.
But if the share price went down to £9.50 in the second month, you'd be able to buy 52 shares, as the shares are at a lower price.
Therefore, rather than your full £10,000 investment being affected by the drop in share price, only a small proportion of your money drops in value. After 18 months of movement in the share price, it might end back on £10.
If you invested with a lump sum, you'd still have the same amount of money and the same number of shares. But by regularly investing, you may end up with more shares and, consequently, some capital growth, despite the share price ending up the same as when you first started investing.
However, it’s important to remember that you may not necessarily benefit in this way using pound cost averaging. The potential downside of pound cost averaging is that if your investment continuously grows in value, you'll miss out on some of that growth.
Also, think carefully about how much it costs you to buy shares. Many fund supermarkets charge you for each trade, so if you are making a purchase every month instead of larger purchases less often, you will rack up transaction charges and these could wipe out some of the gains made from drip-feeding your money.
Find out more: Fund supermarkets reviewed – set up a regular savings plan with a top broker