One of the first (and most confronting) investment decisions anyone has to make is whether to invest a lump sum or work their way into markets slowly.
This question then comes up any time you come into a larger amount of cash. Do you put it all to work right away? Or do you spread your risk out over months and years?
Both approaches are valid. Our video below explains how the approaches differ, as well as who each one might suit.
You might be reading this and thinking ‘who has a lump sum just sitting around to invest?’ If that’s you, then this article will explain how investing a little each payday can be just as effective.
The case for investing a lump sum
The biggest tick in the lump sum column is the age old adage that time in the market beats timing the market. It’s not about backing the right horse at the right time, it’s just a case of staying the course.
Ultimately, the longer your cash is in the markets, the more time it has to grow. Because of this, a lot of investors prefer to get their cash invested, in full, as soon as possible.
This is, however, a stressful idea to a lot of people. There is no guarantee that markets won’t be racked by volatility in the weeks or months after you invest. Your lump sum could get smaller before it has the chance to grow.
There is research that suggests that investing a lump sum outperforms little-and-often investing. For investors only looking for the highest possible returns, putting all your cash to work right away is often the way to go.
The case for little-and-often investing
The beauty of regular investing is that you don’t have to worry about timing at all. By investing little-and-often, you smooth out your entry into markets over time.
What this means in practice is that you’ll buy when markets are low. You’ll buy when markets are high. You’ll buy when markets are mid-cycle. By entering at different points, you’re not making any bets as far as market highs or lows are concerned.
This is, without a doubt, the less stressful way to invest. If investing is about managing your emotions as well as your money, then little-and-often is the way to go.
The problem some people face when they’ve invested a lump sum is that, if markets immediately turn sour (and they can), there’s the temptation to sell to avoid any further losses. This often only serves to cement the losses you’ve already made.
This “regret risk” or emotional risk is exactly why many investors prefer to take the little-and-often approach. You can set-and-forget, secure in the knowledge that you’re smoothing out your market entry.
Backed by decades of theory
Little-and-often investing isn’t a novel idea. It’s been a part of the investment vocabulary since 1949, under the name ‘pound cost averaging’ (‘dollar cost averaging’ for our transatlantic readers).
It’s well accepted at this point that, for investors who want a smooth entry into the markets, smaller, more regular top ups are the answer. It is a risk management tool, as well as a psychological one.
How to set up easy regular investing
With InvestEngine, regular investing is a built-in part of the service. Using Savings Plans, investors can build a portfolio (or invest into a single ETF), set how often they want to invest and how much, and we do the rest.
You might, for example, want to set up your Savings Plan so that money is deposited just after you’ve gotten paid. When your regular top-up comes in, it can go straight into the market without you having to lift a finger.
Also, our AutoInvest feature is automatically switched on when you set up a Savings Plan. This means any cash that builds up in your portfolio will automatically be invested for you, so you don’t end up with cash sitting there idle (you can turn this off if you like).
In the end, it probably won’t matter all that much
Whether you choose to invest a lump sum or drip feed your cash into markets, the long and short of it is that it probably won’t make a huge difference in the long run.
Over a long enough timeframe, short-term volatility gets folded into the wider movements of financial markets. Very few people are thinking about performance on this day two years ago, but they’ll have a decent idea of how much their portfolio has grown in that time.
InvestEngine’s philosophy has always been that taking a long-term view is more important than the specifics of how and when you invest. Time in the market beats timing the market.
The most important thing is building healthy financial habits. Whether that means topping up once a month with a regular investment plan, or it means investing a large sum then leaving it alone, these are both decisions that will give your cash the chance to grow over the months and years ahead.
FAQs
1. What is pound-cost averaging in simple terms? It means investing the same amount of money at regular times (such as weekly or monthly) instead of investing a lump sum all at once. It helps smooth out market ups and downs and makes investing more consistent.
2. How does pound-cost averaging help reduce risk? By investing regularly, you buy more when prices are low and less when they’re high. This helps average out the price you pay and reduces the risk of investing all your money just before markets fall.
3. What are the main benefits of pound-cost averaging? It helps you stay invested through volatile markets, reduces emotional decision-making, builds discipline, and makes investing feel less daunting. It’s an easy way to invest little and often and grow wealth over time.
4. Is pound-cost averaging better than investing a lump sum? Not always, it depends on market conditions and your comfort with risk. Lump-sum investing can give higher returns in rising markets, while pound-cost averaging helps manage risk and smooth volatility in uncertain times.
5. Who is pound-cost averaging best suited for? It’s ideal for beginners and long-term investors who want a steady, low-stress approach. It also suits people investing regularly into a Stocks & Shares ISA, self-invested personal pension (SIPP) or ETF portfolio through automated investing tools like Savings Plans.
6. How can I use pound-cost averaging with InvestEngine? InvestEngine makes it simple with Savings Plans and AutoInvest. You can invest automatically from as little as £20 a month into a chosen ETF portfolio.
7. Can I start investing with a small amount? Yes. With fractional investing, you can start with small regular contributions, such as £20 per month, and still access a diversified ETF portfolio. It’s an affordable way to build long-term investing habits.
8. Does pound-cost averaging guarantee profits? No, like all investing, your capital is at risk. It doesn’t remove risk but helps manage it by spreading your investments over time and reducing the impact of market timing.
9. How does pound-cost averaging work during volatile markets? When markets fall, your regular investments buy more units; when they rise, you buy fewer. This naturally smooths your average purchase cost, helping your portfolio recover more steadily when markets improve.
10. Why should I automate my investments? Automating your regular investments removes the temptation to time the market. Tools like InvestEngine’s AutoInvest and Savings Plans make it easy to stay disciplined and consistent – two key habits of successful investors.
Important information
Capital at risk. The value of your investments can go down as well as up, and you may get back less than you put in.
Tax treatment depends on individual circumstances and is subject to change. ETF costs also apply.
This content is for information only and is not financial advice. If in doubt you may wish to consult a professional adviser for guidance.