This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice please consult us here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Suppose you suddenly find yourself with a cash windfall – possibly from an inheritance or from selling your stake in a business. If you want to invest the money, how should you do this? In particular, is it best to invest everything at once; or, “drip feed” it gradually into a portfolio?
There are pros and cons to each approach which need to be considered carefully. Your decision may be affected by your investment time horizon, your risk tolerance and your wider financial planning goals. Below, our Padiham financial advisers offer some tips to consider.
We hope these insights are helpful to you. Please get in touch for more information or to discuss your own financial plan with us.
Investing a lump sum
Imagine you receive £20,000 as an inheritance. One option is to simply put all of this into an investment portfolio immediately (e.g. in a Stocks & Shares ISA, assuming you have enough remaining ISA allowance). What are the potential advantages?
One possible outcome is that you benefit from the full potential of the market, right away. If the market is experiencing a strong “upswing”, then your money could grow significantly in a short space of time.
There is also evidence to suggest that investing a lump sum can result in greater long-term growth compared to “drip feeding” money into a portfolio. Investing all of the money at once may also be the simplest option. You make the investment and you are done.
However, there are risks to consider. One is market timing risk. Yes, it is possible that you could invest during a market upswing. However, some investors could invest just before a downturn and witness the value of their portfolio decline sharply.
This can cause great emotional stress for investors and lead to significant losses if they sell the investments in a panic, leading to crystallised losses.
Unfortunately, there is no certain way to tell where the markets will go tomorrow, next week or next year. If the market falls shortly after making a lump sum investment, the investor needs to be aware of this possibility and comfortable with it – willing to see out the volatility.
Investing the money gradually
“Drip feeding” the money over, say, 6-12 months (or 1-2 years), can be a more attractive option compared to lump sum investing. This approach is sometimes also called “pound cost averaging” (PCA).
One benefit is that PCA reduces the short-term impact of market volatility on a portfolio. By spreading the investments out over time, the investor can rest a bit easier knowing that a market crash would not pull down the full value of all of their money.
This can create less stress for investors who know that they are not committing all of their investments at once. Some of their investments might occur during a market fall; others during a market rise. In the short term, there is more potential for portfolio stability.
However, there can be an “opportunity cost” to PCA. By keeping a large amount of capital in cash in reserve (ready to deploy to the portfolio in the future), the investor could miss out on potential gains which they may have enjoyed if they invested more in the markets.
Gradually investing your money can sometimes lead to higher transaction costs which eat into your returns (e.g. trading fees). There is also the possibility that, over the long term, you may not get as high overall returns from PCA compared to investing the full amount.
How do I choose the right option?
There is no “correct” answer to this question which applies to everyone. Rather, you need to examine your own unique financial goals, situation, risk appetite and time horizon to weigh the pros and cons of each option. It will help if you do this with the help of a financial adviser.
Let us take the example of inheriting a £20,000 lump sum, again. Suppose one individual has a primary goal of saving for their first mortgage deposit in the next 3-5 years.
In this case, the individual does not have a lot of time to allow for a market recovery if there is a “crash” during the next 3-5 years. Therefore, if they want to invest, they may wish to concentrate more of the portfolio towards “lower risk” assets like UK government bonds and fixed-term cash savings. They may also wish to use PCA if they want to invest any money into equities.
By contrast, another individual is mostly focused on building up their retirement savings for 20-30 years’ time. They are happy to take on more volatility over this period since they will not need the funds for a long time and there are plenty of years for markets to recover from crashes. In this case, investing the £20,000 as a lump sum may be more attractive.
Invitation
If you are interested in starting a conversation about your own financial plan or investments, then we’d love to hear from you.
Please contact us to arrange a free, no-commitment consultation with a member of our team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Reach us via:
T: 01282 772938
