Lump sum vs cost averaging: what is the best ISA strategy?
Studies show lump sum investing leads to slightly better returns, but it might not be right for every investor.
Saving any amount of money per month, or as often as possible, is a great first step towards creating a financial safety net. But if you’re able to, it’s worth looking into your savings strategy to determine whether it’s earning you the best returns.
Two popular approaches are lump sum investing and pound-cost averaging. What do both of these entail, and which one is right for you?
What is a lump sum approach?
Lump sum saving is pretty self explanatory – you take a chunk of cash and put the entire amount in a savings account. Historically, this has generated slightly higher returns. If you do it early in the tax year, you won’t have to think about it further down the line, which makes the admin feel a bit less heavy.
But this approach might not work for everyone, for many reasons. If you do get a lump sum of money, you might be hesitant to put it all into a Stocks & Shares ISA and have its value decrease if the market experiences a downturn, for instance.
If you have managed to save up a significant amount, have received a bonus at work, or an inheritance, you might find yourself with a lump sum of money – but not everyone will be in this position.
Additionally, research from Alliance Witan has found that four in five people put off thinking about the future. This can increase the appeal of making smaller, monthly contributions – it feels like a less daunting choice.
If you’ve already built up a sizeable pot, a platform like interactive investor lets you park your full £20,000 ISA allowance in one hit and then pick from thousands of funds and shares—all under one login.
What is pound-cost averaging?
That’s why some people opt for a pound-cost averaging approach. This just means you’re making a number of investments over time, to avoid risking the whole amount should markets turn volatile. It might make it easier to ride out market volatility.
However, many studies show lump sum investing offers slightly better returns.
Data from Alliance Witan has found that investing a lump sum at the beginning of the tax year provides returns that are 7 per cent higher across 15 years, compared to investing monthly.
The analysis also showed that investors who max their ISA allowances of £20,000 each year across 15 years make a gain of over £180,000. Those who invested a regular amount monthly saw 9% fewer returns.
Previous research from interactive investor shows lump sum investing across a period of 25 years generated returns of 306 per cent compared to 297 per cent for pound-cost averaging.
What is best for you?
Both of these are seriously impressive returns – so there is no one right answer. The best decision for you will depend on your risk appetite, your long-term goals, and your personal preference.
“Each investor is unique and will have their own investment strategy and time horizons,” says Alliance Witan’s Mark Atkinson. “Our analysis finds that the beginning of the tax year is the best time to reap the benefits of investing. But most importantly, it’s about playing the long-game and sticking with your strategy even in times of market volatility.”
“Whether you choose to invest in your ISA with a lump sum, or a mix including monthly instalments, it’s important that this is comfortable and sustainable for you and your lifestyle. Investing in your ISA doesn’t have to be overwhelming or time-consuming,” he adds.
But if you prefer to set‑and‑forget, the Chip app skims spare cash from your current account and automatically invests or tucks it into a high‑interest pot, so you’re building that ISA little by little without really noticing.