In praise of the early bird

As another tax year draws to a close, David Prosser encourages investors to buy and hold.

early bird beach

Happy new tax year – did you beat the rush to use as much of your individual savings account allowance for 2020-21 by 5 April? If so, your 2021-22 Isa might be the last thing you want to think about right now. But there is good reason to do exactly that.

Stock market professionals love their sayings, but one aphorism is particularly important here: it is time in the market that matters, not timing the market. All that really means is that rather than trying to second guess how stock markets might move up and down in the short term, you would be better off investing upfront and then hanging on for the long term.

Time equals performance

From an Isa perspective, a bit of number-crunching makes the point rather more powerfully. Figures just published by the platform Interactive Investor show that someone who invests their full £20,000 Isa allowance in an investment company at the start of each tax year would end up with a portfolio worth £264,136 after 10 years, assuming they earn an average return of 5% each year from the fund. By contrast, someone who invests on the final day of the tax year instead – and therefore gets only nine years’ worth of growth – would end up with £251,558. That is almost £12,600 less.

Over 20 years, the effect is even more significant. Early-bird Isa investors would end up with an investment company holding worth a whopping £33,000 more than those leaving it to the last minute to use their Isa allowances.

Interactive Investor’s most successful clients have recognised this. Amongst the platform’s wealthiest investors – those with Isa holdings worth more than £1m – 37% have been making their annual Isa subscriptions in the first three weeks of each tax year. Among the rest of its client base, the figure drops to 20%. (It is also no coincidence that Interactive Investor’s Isa millionaires hold disproportionately large amounts of their portfolios in investment company shares.)

There is nothing particularly smart about this idea. Investing earlier in the tax year simply means your money has more time to grow – and to earn dividend income, which you can reinvest. And over time, the effect of compound interest is to multiply this beneficial effect.

Little and often

There is, of course, a fly in the ointment for many investors. Not all of us have £20,000 sitting around ready for investment so that we can use our new 2021-22 Isa allowance straight away. And if you have just made a substantial investment in order to grab last year’s allowance, it is even less likely that you have got that sort of disposable cash available.

In which case, the answer could very well be a regular savings plan. These arrangements allow you to drip feed your money into your chosen funds through regular monthly subscriptions, rather than making a single lump sum investment upfront. To use your full Isa allowance this way, you would need to commit to a monthly investment of around £1,666, but the fund platforms accept far smaller amounts if these are more manageable – as little as £25 a month in some cases.

Regular savings plans have an additional advantage on top of their affordability – they can also smooth out some of the ups and downs of stock market investment. In months when the market has fallen, your fixed monthly cash investment buys more shares; then, when the market rebounds, you see the benefit of this. Over time, the effect is to dampen volatility.

The message is clear. If you can afford to use your Isa allowance early in this new tax year, it makes sense to do so. But even if you do not have the cash to invest upfront, consider a regular savings plan that puts your money to work as soon as possible while providing some smoothing benefits.