Will you earn more investing all at once or monthly?

Taking your money out of a savings account to put into the market might feel like standing on the edge of a high dive.

So, it makes sense that many investors choose to wade in, by investing just a bit each month, before building up the courage for a full plunge.

The idea of ‘a little bit often’ feels intuitive because it’s the way we approach many things in life. You can’t cram learning a language into a day, but you’d likely improve by spending just 30 minutes on it each day. Psychologically, this makes sense for us. But when it comes to the math of the markets, history has pointed to a lump sum investment performing better over time.

The proof is in the pudding

Let’s take two investors, Wade-in Will and High-dive Heidi, who will both invest £1,200 over the course of each year. On the first of each month, Will makes an investment of £100 into a fund tracking the MSCI World index. Heidi chooses to make just one investment each year, of £1,200, at the beginning of the year.

If both Will and Heidi started investing on 1 January 2006, 20 years later, on the 31 December 2026, Will would have £86,322 while Heidi would have £88,023 after charges. This makes the annual investor nearly £2,000 better off. But what if the duo started investing right before a market drop? Let’s say both investors started in 2008 instead, right ahead of the Great Financial Crisis. Even though Heidi’s investment would have entered the market right ahead of a massive crash, and Will wouldn’t have had all his annual payments in the market by then, Heidi would still end up better off by 2026, with £73,121 to Will’s £71,832 including fees.

Using your ISA allowance

This can be a useful statistic to know when it comes to ISA subscriptions, when the new year starts on 6 April. For some of us, putting the entire amount of money we plan to subscribe to our ISA for the year by the 6 April just isn’t plausible. As seen in the graph, in the grand scheme of things, the differences in return are minimal. And monthly investing can have some perks, like reduced charges on regular investments.

But for those with significant amounts sitting in cash, investing the money as soon as a new ISA allowance becomes available could possibly yield a few extra thousand in the long term.

Your risk level is also an important consideration in this. If you choose to invest as a lump sum but then get spooked by a market dip and take that money out, you could end up doing worse than if you just made a monthly investment and stuck with it.

Why does it work?

Why does a lump sum often do better in the market than spaced out investments? It comes back to compounding, which is all about the snowball effect. Over the past 20 years, the MSCI world has generally increased, which has a positive growth effect on the money in the market. By putting the money in the market at the front end, you’re essentially giving your investment a head start, because the market has the opportunity to apply growth to that whole £1,200. If you’re putting £100 each month, by the end of the year the market will be working with a whole £1,200, but at the beginning, it has much less money to work with and therefore does not snowball as quickly.

For example, let’s say an investment grew by 5% a year after charges, and that growth was spaced out evenly over the year. A £1,200 investment at the beginning of the period would accrue £61.39 by the end of the year, because it was building on the £1,200 the whole time. The power of compounding would generate an extra £5 in the first month, and by the last month, would generate £5.23.

But, if you invested £100 on a monthly basis, you’d only make £33 through market growth by the end of the year. Your first month would onlyresult in 42 pence through market returns, and it would increase to £5.12 by the last month, missing out on significant gains.

In practice, of course, the market does not perform at such an even keel. It could go up and down throughout the year, or fall on the year as a whole, which would cause a drop in value like we saw in 2008. But overtime, the math that backs up lump sum contributions will give it a chance to catch up again.