Feel benefit of keeping regular with investments
Drip feeding your cash can smooth market highs and lows. By Chiara Cavaglieri and Julian Knight
Another tax deadline has come and gone and many individual savings account (ISA) investors are resting easy. But perhaps it's time to make a new tax year resolution. The start of a fresh financial year is the perfect opportunity to reassess your strategy and, if you're taking a punt on the stock market, regular investing could be the best tactic.
"I'm a big fan of monthly investing," says Jason Witcombe at the independent financial adviser Evolve Financial Planning. "By investing into an ISA monthly, the only decision you have to make each year is whether to increase the savings when the allowance goes up.
"You avoid the last-minute rush and worry about whether now would be a good time to invest. It takes the market timing decision out of the investment equation."
Deciding how long you want to invest for and how much you can afford to put away is usually the first step to take, but the method you choose could also have a significant impact. Essentially this boils down to two choices: you can invest money as a lump sum by putting in all of your savings immediately, or through regular contributions. This may have as much to do with your individual circumstances as your attitude to risk, but even less cautious investors should consider drip-feeding their money into the markets.
Markets have always been difficult to predict, even for the professionals, but in the wake of the global financial crisis, this has proved even more of a challenge. Monthly investing is one of the simplest ways to combat volatility because the value of your investment will not change dramatically.
The benefit of a single, monthly investment is "pound cost averaging" – by investing the same amount each month and therefore buying your assets at different prices as the market moves, you can ride out the highs and lows. In the early months only a small proportion of your money benefits from any returns – but if markets fall, only part of your investment is subject to any losses and the next time around, your regular investment buys you more units for less.
"Investments will fall in value as well as rise but, with regular savings, falling markets allow you to buy more of the investment at lower prices, so if the market eventually regains the lost ground they will count for much more," says Danny Cox at the fund platform Hargreaves Lansdown.
"If the market rises you profit from the increasing value of investments already made. Providing you encash your plan when the price is higher than the average you've paid, you will make money. It is an excellent way to help smooth out the ups and downs in the market."
Typically, you can invest from about £50 per month in a stocks and shares ISA, via discount brokers, fund platforms and other providers, up to the full annual allowance which rises to £11,520 for the 2013-14 tax year. Most funds allow you to set up a regular savings scheme, but the better plans provide flexibility to stop, start or alter your contributions at any time without penalty.
Many providers don't charge extra for regular investing when it comes to funds, but if you want to invest in exchange-traded funds and individual shares, dealing costs generally make monthly investment prohibitive.
If you're just starting out as an investor, monthly investing is particularly useful as a means of monitoring your investments and developing the discipline of putting money away on a regular basis.
Mr Cox says: "Those who are nervous of markets or cannot immediately decide which investments to choose, can invest their full ISA subscription into a cash account or cash park within their ISA and then take their time making their choices, drip-feeding their money into the market over time."
Despite this, there are still significant benefits to lump-sum investing, so experienced investors may prefer to combine the two strategies.
Over the long term, lump-sum investing has the greatest potential for reward, but only if you are prepared to keep your money invested and give it time to recover from the ups and downs. Realistically this requires a lot of patience and a knack for market timing, so splitting your money into both regular contributions and a full investment seems a sensible approach.
Annabel Brodie-Smith of the Association of Investment Companies says: "Generally, over the long term, lump-sum investments outperform regular saving. So, for example, a £50-a-month investment into the average investment company over the past 10 years gives a return of £9,919 whereas the equivalent lump sum invested in the average investment company over 10 years gives you a return of £19,924.
"However, if you had invested just before the credit crunch five years ago in February 2008, saving regularly outperforms a lump sum investment, so £50 a month invested regularly over five years in the average investment company is now worth £4,041 whereas the equivalent lump sum of £3,000 invested in the average investment company over five years is worth £3,792."
If you are confident in a particular asset you can invest beyond your monthly contribution, exposing a set amount to immediately benefit from any increase in the price of shares, bonds and unit trusts, without the risk that you could blow the lot. If there are any fluctuations in the market your entire investment won't follow suit and, even better, you can make the money you're keeping back work as hard as possible by placing it in a high-interest cash savings account.
Arguably, regular investing doesn't work quite as well for cash savings. Dedicated regular savings accounts do offer some of the top interest rates – First Direct current account customers can earn 6 per cent with its Regular Saver. However, these accounts tend to be fairly strict, limiting withdrawals and restricting how much you can deposit – typically between £50 and £300 a month.
If you can find a standard savings account with a similar rate of interest, you will earn more paying in a lump sum instead of monthly deposits. If you want to shelter this from the tax man, go for a cash ISA, limited to a maximum of £5,760 for 2013-14, and the sooner you can invest, the more interest you will earn.
Independent Partners; request a free guide on NISAs from Hargreaves Lansdown
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