Which is better – a lump sum or regular saving investment?

• Lump sum investing can return considerably more than regular saving investing over the long term
• However, the advantage of lump sum investing just before a market rout is more muted
• A regular saving plan comes with less dramatic falls in value along the way
• ISA investors are by nature regular, and the long run difference between monthly ISA saving and annual ISA saving is relatively small
• The benefit of monthly saving and why now is the perfect time to set up a regular saving plan

Laith Khalaf, head of investment analysis at AJ Bell, comments:

“The power of compound market returns is a humbling force, which tends to favour lump sum investing over monthly savings, simply because more of your money is in the market for longer. But when it comes to the losses you sustain in market downdrafts, it’s the regular savings plan which wins the day, because less of your capital is exposed, and your monthly contributions continue to buy shares at cheaper prices.

“As we approach the end of the tax year, many investors will be stuffing lump sums into their ISAs to beat the call for last orders on 5 April, but there are compelling reasons why they might set up a monthly ISA investment plan at the same time.”

Lump sum vs regular savings

“Returns over the last twenty years suggest that you should get your money into the market sooner rather than later. A £20,000 lump sum invested in the typical global equity fund 20 years ago would now be worth £118,570. A comparable regular investment plan of the same amount in total, or £83.33 a month, would now be worth £51,360, less than half the value, despite the same outlay in cash terms. However, these figures do come with large caveats attached.

“If you have £20,000 to invest as a lump sum, but decide instead to drip feed it monthly into the market, then you can expect to get interest on it while you wait. This could boost returns significantly over long periods of time. Assuming a 4% interest rate on standing cash, £20,000 invested in a global equity fund in monthly chunks of £83.33 over the last 20 years would now be worth £70,295. However, that still falls far short of what a lump sum investment would provide, again as a result of the higher compound returns provided by the market.

(N.B. It almost certainly wouldn’t have been possible to attain 4% on cash over the whole 20 year period because of the exceptionally low interest rates in force between 2009 and 2022, but this nonetheless serves as an example of what might be possible under more normal monetary conditions).

Sources: AJ Bell Morningstar, based on total returns from the IA Global sector to 28 February 2023. The £20,000 invested in the regular savings plan is split over 240 monthly instalments of £83.33 each, with and without interest of 4% paid on the uninvested sum.

“Another caveat relates to the precise timing of your lump sum investment, because this can have a substantial effect on the final value of your pot. Investing a lump sum 20 years ago was a pretty lucky time to be putting money to work in stocks, seeing as it was the bottom of the 2003 bear market. But even a lump sum investment made at a much less auspicious time still delivers a higher final value than a regular savings plan, though the gap between the two is much smaller. A £20,000 investment in the average global equity fund made in October 2007, just before the global financial crisis, would be worth £58,636 today. That compares with £54,336 if invested in a comparable regular savings plan of £108.11 a month, earning 4% interest on standing cash, or £42,476 with no interest.”

Sources: AJ Bell, Morningstar, based on total returns from the IA Global sector to 28 February 2023.

Monthly vs annual ISA saving

“Very few people, if any, simply invest just one lump sum during their whole life, however. Certainly most Stocks & Shares ISA savers are regular investors, even if they may not be paying in monthly. The annual ISA limit means even lump sums go in at regular frequencies, usually each year. So the most relevant comparison to be made is really between investing a lump sum in an ISA annually compared to a monthly investing plan.

“As the chart below shows, the difference is relatively small. A regular Stocks & Shares ISA investment of £1,000 a month for 20 years, invested in the average global equity fund, would now be worth £616,315. The same amount invested annually in an ISA, £12,000 a year, would be worth a bit more at £644,853. That’s a 5% positive swing in the value of your ISA pot by investing annual lump sums rather than monthly savings. So whether you choose to invest in an ISA monthly or annually, over the long term you’re likely to arrive at roughly the same destination, as your money is exposed to the market for a similar amount of time.”

Sources: AJ Bell Morningstar, based on total returns from the IA Global sector to 28 February 2023.

Benefits of a monthly saving plan

“While a regular saving plan may not win the race outright in terms of generating the biggest pot size compared to lump sum investing, there are some reasons why investors should still consider it.

“The first is that you get a smoother journey. Our £20,000 lump sum invested in 2003 generated a current value of £118,570, compared to £51,360 from a monthly saving plan of the same overall amount. However, the biggest fall sustained in the value of the lump sum investment over this period was 34%. That compares to 24% from the regular savings plan, because money is going into the market more gradually. The picture is more stark when you put this in pounds and pence, with the lump sum investment falling by £14,076 during the financial crisis, compared to just £1,635 from the regular savings plan. The cushion to losses provided by a regular savings plan is in part determined by the timing of the market fall. The later the fall occurs, the greater the impact on the regular savings plan, because more capital is exposed to the market.

“A similar dynamic applies to the monthly saving and annual saving ISA. The biggest sustained fall in a £12,000 annual ISA saving journey since 2003 was 31.5%, or £30,726. For a £1,000 monthly savings ISA the biggest fall in value was 23.7%, or £19,620. This reduction in volatility isn’t an entirely free lunch, because annual ISA saving has still delivered a slightly higher value over this period than monthly ISA saving, but it has come at the cost of just a 5% reduction in the final capital value. So if you don’t have the stomach for big falls in the value of your investments, the more regularly you can save, the better.

“There are also some less numerical reasons for investing monthly. Lump sum investing is all well and good, but you do need to have a large chunk of money available to be able to do it. Regular saving, by contrast, can simply be drawn from monthly earnings. A regular savings plan also takes the hassle out of putting money aside and the temptation to try and time the market with lump sums, because the cash is taken automatically from your bank account every month by direct debit and invested according to your standing instructions. A monthly ISA savings plan also eliminates the chance you might forget to use your annual ISA allowance.

“One disadvantage of investing in a regular savings plan, if outside of a SIPP or ISA, is it can make it more challenging to calculate capital gains, because the base cost of your investment is continually changing. Relatively generous SIPP and ISA contribution allowances, along with a £12,300 annual CGT allowance, means this isn’t an issue for most investors. However the CGT allowance is set to be cut to £3,000 over the next two years, which might make the nuisance of calculating capital gains a more common imposition.

“The back end of March is actually an opportune time to set up a regular ISA savings plan, because it aligns your monthly contributions with the tax year. That’s because your first payment will be taken in April, the first month of the new tax year, so you are able to get a full twelve months of regular contributions going into your ISA. This is especially useful if you are planning on maxing out your ISA allowance at £20,000, split into twelve monthly contributions of £1,666.66. Otherwise, if you start a monthly savings plan of this amount part way through the tax year, at some point you will need to add a lump sum investment to top it up to £20,000 along the way.”