Drip feed vs lump sum investment strategies: what you need to know
Drip feed investing involves making small regular monthly investments over a number of years. The lump sum investment strategy involves making one large lump sum investment at the start and holding it for a number of years.
If you are young or a millennial and can only afford to make small monthly investments, then this will dictate that you invest via drip feeding.
If you are a baby boomer with a large sum of money to invest (perhaps from pension freedoms) then the lump sum strategy may be more appropriate as long as you can accept the volatility you will face. If not you may be drawn towards the drip feed investment strategy, albeit making larger monthly investments.
The benefits and drawbacks of each strategy
The biggest benefit of drip feed investing is a concept known as ‘pound cost averaging’. This is the idea that by making small regular payments the investor smooths out the highs and lows of the market, buying fewer shares when prices are high and more when prices are low. The drawback is that you may miss out on the full benefit of rises in the markets in the early years as you will have a much smaller sum of money invested.
The biggest benefit of lump sum investing is that the investor benefits from having the whole sum invested from day one to benefit from any potential rise in the markets. However, the same is true of potential falls in the markets as the whole investment sum will be exposed to the fall.
Another major drawback to lump sum investing is the risk that you make your lump sum investment at the top of the market which can have a significant impact on the return you receive.
It is notoriously difficult to ‘time’ the market. The real key to a successful investment strategy is time in the market (investing for the long-term).
Which strategy can achieve better long-term returns?
We have completed some analysis using the IP UK Companies fund looking at the return over 20 years from November 1997 using a lump sum of £12,450 compared to a regular investment strategy based on a £500 initial investment followed by monthly investments of £50.
Adjusting for inflation we found the lump sum delivered a superior return of £34,304 compared to the regular investment which returned £24,562.
It is important to note from some further analysis we completed that when you make your lump sum investment (top or bottom of the market) can make a significant difference to the return generated.
In particular, if you invest your lump sum at the very top of the market the regular investment strategy actually outperforms the return from the lump sum.
What are the costs involved with drip feed and lump sum investing?
If you were to invest via a D2C platform (direct to consumer), there are a number of potential charges you would face. You may have to pay an annual platform charge based on the value of your investments held on the platform (normally a percentage fee).
Or you may have to pay an annual product charge for the products you are using (General Investment Account, ISA, Self-invested Personal Pension) which is usually a flat rate. Or you may face a combination of both.
Also, if you invest via funds you will be liable for the fund management charges which are taken directly from the fund’s assets.
Most platforms don’t charge for fund trading/changes, however charging for exchange-traded products is much more common. The impact from 12 dealing fees per year compared to only one on the return generated by the investment could be significant.
To compare charges of the different platforms based on the investments you plan to make, you can use the free platform calculator at Comparetheplatform.
Dr Tim Burrows is research and analytics manager for Fundscape and Comparetheplatform