Lump sum or cost averaging: What’s the best way to invest my £10,000?

I opened a general investment account during the pandemic and started investing £100 each month. Since the cost of living crisis, I have had to stop my monthly contributions, but I intend to start them up again as soon as possible.

I don’t have an emergency fund at the moment, but I got about £10,000 from family and I want to invest this. Should I invest all of this in my GIA in one go or should I put in a fixed amount every month?

I’ve heard of something called cost averaging, but I’m not sure what it means and if it’s the best thing to do in the current period of market volatility.

What should I do?

Angharad Carrick of This Is Money replies: You are right to consider your options when it comes to lump sum investments, not least because we are headed for a recession.

Of course, your approach will depend on your goals – do you want to buy a house or put this money into a pension, for example?

With a lump sum of £10,000 you can choose to invest all at once or you can invest it in smaller increments into something called cost averaging.

Flat-rate investing does what it says. You put your money in the market in one go, giving your investments more exposure to the markets.

There are pros and cons to this approach. If the market rises from there, you will benefit, whereas if you invest your money over a longer period of time using a cost averaging approach, you would buy stocks at a higher price.

However, if the market fell after you put in the entire £10,000, your entire investment would fall. Cost averaging allows you to limit your losses.

Time in the market beats the timing of the market, as financial advisors like to remind us, so investing the money as soon as possible is positive.

Savings Scarcity: With inflation rising, money in savings accounts loses value in real terms – so investing may be a better approach in the long run

Interest on cash held in savings accounts won’t be able to beat inflation, as even the best rates currently pay only about 5 percent – so the remaining money will lose value in real terms.

Flat rate investing certainly works if you are comfortable with a higher level of risk. If you are not comfortable with this, you can opt for cost averaging, when you add up the money over a longer period of time.

This can reduce some of your anxiety as you add a fixed amount to your portfolio each month regardless of market conditions.

I asked Dr Robin Keyte, Certified Financial Planner at Keyte Chartered Financial Planners, for his advice. He said:

I am not sure what stage of life you have reached, how you meet your usual living expenses, whether you have earned an income or are retired, whether you have survivors, etc. It may therefore be helpful to start with some general points to watch.

Inflation is the persistent challenge we all face and is particularly relevant today with a CPI of 10.1 percent. If your capital does not achieve a return that exceeds inflation, it will fall in value in real terms. By that I mean what you can afford to buy is reduced.

Historically, one of the main asset classes that delivers long-term returns in excess of inflation is equities. However, the value of equity investments can be volatile and rise and fall rapidly.

So first of all, it’s important to think about what happens if investing doesn’t work.

Investing fails if for some reason you have to sell your investments at a time when the markets are down. We want to think about how to invest in a way that reduces the chance of this happening.

Reasons you may be forced to sell your investments could be if you need to raise money for an unexpected obligation, such as replacing a car or making up for lost income if you’re surplus to requirements.

With that in mind, we should initially consider how much you should set aside as an emergency fund for accessible cash savings. I would suggest that you consider what equates to 3 months of income, or 3 months of living expenses.

You may also want to consider whether you have potential capital expenditures over the next two years and whether you need to set aside savings for that as well.

Since this is a family gift and it is treated as a Potential Exempt Transfer (PET), another issue may be whether you as the recipient would be responsible for any future inheritance taxes associated with the PET if the donor dies within seven years of death. the gift.

Taking the above into account, consider investing the £10,000 residue.

As for the question of investing in volatile markets and the average cost of pounds, we agree to phase the new investment in over a period of perhaps six to twelve months, with the aim of reducing the likelihood of you trading at higher or more expensive stock prices.

Angharad Carrick adds: You seem determined to restart your investments, which is a wise idea given the power of compounding.

Often times, investors exit the market during difficult times and only re-enter when the market begins to recover.

This locks in losses and means you can miss out on some serious winnings. If you put that together over a long period of time, it can make a big difference.

Robin has recommended building an emergency fund before investing. Perhaps you could put the £100 a month you planned to invest in an emergency fund instead.