Investing as a Lump Sum versus Regular Investing: A New Perspective

There are many articles and even academic research papers that address the question of whether it is best to invest as a lump sum or to invest regularly. In this article we are taking a different perspective to the standard binary of one better one worse.

We will start by reviewing some of the core information that is out there before getting into our view of this dynamic, reframing the question.

The traditional question asks whether you should invest a lump sum into an investment in one amount or in several small amounts over time.  The approach of breaking an investment into several smaller amounts is called Dollar/Pound/Euro Cost Averaging.

Those in favour of investing a lump sum amount present the advantage that you are in the market sooner and remain in the market longer which creates the opportunity for greater returns.

For those advocating for breaking an investment in several smaller amounts and investing it over a period of time, for example, instead of investing €120,000 in one amount, investing €10,000 each month for a year, state that it allows the investor to obtain an average price and avoids short term volatility. This is why they call it cost averaging.

The real advantage of the gradual approach is behavioural. It might reduce stress for an investor that is worried about market movements or making large transactions. There is a disadvantage though that ten small transactions may be more expensive than one single transaction when buying into investment assets and transferring funds.

The research is quite clear that making a lump sum investment results in better long term returns in most circumstances. This is because markets go up more than they fall and they rise over time. If you are invested longer, your returns will be higher.

The exception to that is if it is a particularly volatile period or if you make a lump sum investment just before a market correction. This is a rare occurrence though.

This leads to a further question of whether an investor should invest or wait until a market looks more positive.

To address this, we return to the point that we have made in many articles, that it is virtually impossible to time a market. The objective of making an investment is a bit like shopping: you should be trying to seek lower prices, not higher ones. By waiting for a more favourable investment market, you are essentially buying in at a higher price after markets have generated returns. We have seen several investors over many years state that they wanted to wait for a market correction before investing, only for the market to continue to grow and the investor sitting in cash missing out on returns.

Reframing the question

At Black Swan Capital we do not think it is a question of whether you should make a lump sum investment or spread the investment over time. We believe they are both viable strategies that should be used in different circumstances.

First, we recommend you follow the actions that best align with your objectives.

Then, when it comes to lump sum investments, with rare exceptions, we recommend you invest as a single lump sum and do not break it into several smaller amounts. Why? Because the research shows that in the long term it leads to better returns.

But we also recommend that investors utilise cost averaging to build their wealth and hit their goals. A great way to use this is to add to your investment monthly. You can choose to save up money each month and make an investment addition every year, or you can add smaller amounts every month. It is better in most cases to do the latter for several reasons. These include that as you are in the market sooner, you will be invested longer and generate more returns. Second, it allows you to take advantage of short-term volatility. If a market falls one month this is not such a bad thing if you are adding to an investment every month, as it means you are buying at a discount price that month. Third, it creates a good discipline, and finally, you benefit from the benefits of compound interest that accelerate your wealth accumulation over time.

The question therefore is not whether lump sum or regular investing is better. Subject to advice and your specific circumstances, it is often better to make a lump sum investment when you have larger amount and benefit from the cost averaging by adding to your investment monthly from your cash flow. That is, do both!

Before you start, get advice. Speak with us at Black Swan Capital.