Upfront investment or regular savings?

Have you used up this year’s £20,000 individual savings account (ISA) allowance yet, or are you contributing over the course of the 2023-24 tax year rather than investing a single lump sum? Not everyone has the luxury of choice – it may depend on how much cash you have to spare – but the debate about the merits of regular savings versus upfront investment are finely balanced.

In one corner, fans of the regular savings approach point to its virtues during volatile periods for stock markets such as now. If markets are jumping around all over the place, taking the plunge with a large upfront investment on any one day feels like too much of a gamble, they argue. In a regular savings plan, by contrast, you can take advantage of a statistical concept known as pound-cost averaging. In months when prices are low, your fixed monthly investment buys more fund shares or units – and vice versa in months when prices are more elevated. The effect is to smooth out volatility over time.

The counter argument is that the impact of compound interest trumps all. The sooner you put your money to work, the sooner you’ll earn returns on it; and over time, those returns earn returns of their own. Compound interest is therefore a hugely powerful driver of investment gains and that power grows over time.

The good news is that the investment companies sector serves both camps very well. In fact, investment companies were pioneers of regular savings schemes in the UK, with most funds offering investors the option of putting in small monthly sums – often as little as £25 – rather than staking a larger amount upfront. Today, those arrangements remain very popular, but they are typically run by the large investment platforms and online brokers, rather than funds themselves.

One of those brokers, Charles Stanley, published data on this question very recently, and its figures underline the nuances of the debate rather well. It looked at the results of investing £50 a month or £600 at the start of each year over several periods to 31 March this year. The broker assumed the money went into a mix of global equities, as represented by the MSCI World Index of stock market performance.

Strikingly, an investor who put £600 into these shares at the beginning of April 2022 would have been worse off by 31 March than a counterpart who invested £50 a month over the course of the year. The former would have ended up with £605 to the latter’s £658, Charles Stanley calculates.

That reflects the turbulence we saw on global stock markets throughout 2022, with many experiencing sharp sell-offs. In other years, the results would have been different – but the data underlines how regular savers are protected from the effects of volatility. Smoothing really worked over this period.

By contrast, over longer periods, the power of compounding is clear. Over three years to 31 March, regular savers would have ended up with £2,053, but lump sum investors would have managed £2,739. Over five years, the figures were £3,801 and £5,039 respectively, rising to £10,473 and £17,270 over ten years.

The important point here is that there are no guarantees. In this exercise, regular savings worked well to counteract short-term volatility, but the impact of compounding kicked in over longer periods. However, that reflected the nature of the performance of markets over these timescales – they rose over the medium to longer term but were more volatile in the short-term period. Had markets fallen over the extended periods, regular savings plans would have done better.

Still, if you’re investing in stock markets on the basis that they have, at least in the past, tended to deliver more growth over extended periods, the lesson from Charles Stanley’s data is clear. Upfront investment drives larger returns over time in a generally rising market – and the gap widens over longer periods.