Take the stress out of investing and watch your savings grow by drip-feeding your money into the markets each month. We explain how it works
Everyone will know someone who bought some shares or invested in a fund just before it rocketed, or sold them just before they plummeted. But whether these successes were down to meticulous research, a tip or simple luck, it is a feat few can consistently repeat.
For every brag in the pub or dinner-table boast from cock-sure investors there is more than likely a string of losses that they are not so willing to divulge.
“Buy low, sell high is a frequently quoted investment saying, but one that is extremely difficult to put into practice,” says Moira O’Neill, head of personal finance at Moneywise’s parent company interactive investor.
“This is simply because, short of having a functioning crystal ball, it is almost impossible to identify market peaks and troughs.”
Sarah Coles, personal finance analyst at Hargreaves Lansdown, agrees: “Some people like to move lump sums over from cash when they feel the markets are cheap and ‘buy on the dips’, but this requires accurate and successful timing of the market, which is notoriously difficult.”
Trying to time the market is not only hard, it is also high risk. Fail to sell or buy into an investment at the right time and you stand to not only crystallise your losses when markets fall but also miss the best days when they recover.
But the most successful investors are not always those who spend their spare time poring over charts and monitoring companies’ performance obsessively. Some of the most profitable investors are those who have a much more laid-back approach.
Rather than taking big punts with large sums, they invest little and often, pumping smaller amounts of money into their chosen investments regularly, irrespective of whether markets are rising or falling.
As this example from Hargreaves Lansdown, shows, ‘time in the market’ is often a better strategy than ‘timing the market’.
Take ‘Lump Sum Larry’: feeling emboldened on 1 January this year when the stock market was around its peak, he invested £1,200 into a fund that tracks the FTSE 100 and was able to buy 482 units.
Markets – as we all know – have since plummeted and Larry’s investment is now worth just £944.
‘Regular Rebecca’, meanwhile, started investing back in May 2019 and has been paying £100 into the same fund as Larry ever since, but how many units she has been able to buy each month has depended on stock market performance. Over the period she has invested £1,200, just like Larry and into the same fund, but she has been able to buy a total of 516 units and her pot is worth £1,011.
Given the impact of Covid-19, it is no surprise that Larry and Rebecca have lost money – but not only has Rebecca lost less than Larry she also has more units, placing her in a better position for when markets recover.
So if neither of them invested anything else and markets rose by 30%, Larry would end up just about where he started, with £1,227, but Rebecca would be sitting on a more impressive £1,315.
The reason that Rebecca is better off in both outcomes is that she has been able to take advantage of mathematical wizardry known as ‘pound cost averaging’.
Setting up a regular savings plan
It is simple to set up a regular savings plan with investment platforms, including AJ Bell, Fidelity, Hargreaves Lansdown and interactive investor.
Myron Jobson, personal finance campaigner at interactive investor, says: “Setting up a regular investing plan is an easy and painless way to save for the future. Similar to household bills, you can set up a direct debit to take a specified amount out of your bank account every month.”
Accounts can be opened from as little as £25 or £50 a month.
When selecting a platform, it is important to check charges. Many platforms offer a reduced trading fee for regular savers. For example, interactive investor scrapped its regular trading fees in January, while AJ Bell charges regular investors a fee of £1.50 (standard dealing charge is £9.95).
Hargreaves Lansdown charges £1.50 for shares and investment trusts while fund dealing is free (its standard dealing charge for shares is between £5.95 and £11.95, depending on the number of trades you make). Each platform will also have its own platform fee so it’s important to balance both charges out.
“When weighing up the right investment platform for you, it is important to look at the service on offer, as well as the administration and dealing fees, plus any other extra costs,” says Jobson.
“It is also important to explore the available investments. Not all platforms facilitate the purchase of shares and investment trusts, for example. Charges and services vary but the best investment platform is the one that fits your personal circumstances.”
Annabel Brodie Smith, director of communications at the Association of Investment Companies, explains: “With regular investing, if markets fall like they have done recently, you buy more shares each month when the prices are lower.
“Similarly, when share prices are higher, you will buy fewer shares. This is called pound cost averaging and it is an effective way of smoothing out the volatility of markets over the long term.
“It provides some reassurance that when markets go through a tough time you will be taking advantage of this.”
Ed Monk, associate director for personal investing at Fidelity, agrees with this and adds. “Buying at a variety of prices and spreading ongoing investments over time also helps to cushion your portfolio from dips in the stock market.”
Pound cost averaging and regular saving work fantastically well when markets are going up and down.
However, it is important to mention that it might not guarantee you the best possible outcome, as Laura Suter, personal finance analyst at AJ Bell, explains: “The flip side is that if markets continually rise through the year you could miss out on higher returns. If markets rose every month in the year, then you would be better off putting all your money to work at the start of the year and having it invested in the markets for longer.
“For example, if you had invested £12,000 in the FTSE 100 on 1 January 2009, you would have ended up with £15,280 by the end of the year. Whereas if you had invested £1,000 each month during that year you would have £14,845 at the end of the year – £435 less.”
But while investing a lump sum can in some situations be more profitable, it is substantially higher risk than drip-feeding your money into the market.
“Studies have shown that lump sum investing can work better over the long term as more of it is invested earlier,” points out O’Neill.
“But for many a big lump sum investment would keep them awake at night with the worry that they had timed it badly.
“So, the regular investing approach that guards your investments from rapid rises and falls in markets might be a price worth paying.”
By reinvesting their proceeds, investors also get to enjoy another example of mathematical magic. Albert Einstein famously described compounding interest as the eighth wonder of the world; by leaving your money invested, the returns that your money earns boost your savings even further.
As Monk says: “Investing regularly allows you to benefit from the power of compounding – the snowball effect of generating returns on previous returns – which can significantly boost the value of investments over time.”
Pound cost averaging and compounding returns are a formidable combination, and together they mean regular savers do not need to put away huge sums each month.
Suter explains: “If you put away £50 a month over 10 years, assuming investment returns of 5% after fees, you would build up a pot of £6,910, while over 20 years you would end up with £19,175, showing how a small amount each month can really add up over time.”
But the benefit of investing regularly is not just about the maths: it can also help from a psychological or behavioural point of view.
Monk says it takes emotion out of the equation and means your heart will not end up ruling your head.
“By adopting this approach, you remove your built-in biases and assumptions automatically and dispassionately, and so you are less likely to try and predict how markets will behave.”
Coles points out that investing regularly with smaller sums can also be a lot less daunting for beginner investors.
“Regular investing is a brilliant way to get started with investment, because you don’t need to be able to lay your hands on a huge lump sum,” she says. “By investing every single month, you also take market timing out of the picture entirely.
“If you were to put a one-off lump sum into the market, there’s a risk that you could time it badly and markets could fall the following day. By spreading the investments, you’re spreading this risk.”
It can also be helpful from an organisational point of view, says Suter.
“A big advantage is that that you don’t have to remember to invest your cash each month – everyone has a ‘life admin’ list as long as their arm, and often it can be easy to plan to invest money but also easy to forget to do so.
“This means that rather than your money sitting in cash for three months before you remember to invest it, with regular investing automatically buying the funds or shares you’ve selected, you’re getting access to investment markets during that time.”
Now is admittedly a daunting time to start investing. At the start of 2020 the FTSE 100 was riding high, peaking at close to 7,700 by mid-January, but over a matter of weeks it plummeted as coronavirus spread across the globe, bottoming out at around 4,900 on 23 March, the day Prime Minister Boris Johnson announced the UK lockdown.
However, Coles says this should not put investors off setting up a regular savings plan – providing they are in a financially secure position.
“It only makes sense to invest money you definitely won’t need for five to 10 years or more, so if you don’t have any savings for emergencies, this should be your first port of call.
“If you are managing on a lower income and having to work hard to make ends meet you may also struggle to free up £25 a month.
“But if you have the money to set up a regular savings plan now, then it is a great time to do so because many funds and shares are far cheaper than they have been for years, so your money will go further from day one.
“It is also an incredibly valuable approach during times of volatility because you get more for your money when shares are down, and then you can benefit from the rises.”
Choosing the right funds for you
You will need to consider where you want to invest your money, too.
Funds managed by an expert on your behalf are significantly lower risk than buying individual company shares. Funds that track an index such as the FTSE 100 or the FTSE All Share can be a very cheap way of investing.
As they simply mimic stock market performance your fund will never beat the market, but they won’t lag it either. For more inspiration, check out Moneywise’s First 50 Funds for Beginners. It includes low-cost trackers, actively managed funds across a variety of geographical regions and investment trusts.
Alternatively, look at the winners and runners-up in the Moneywise Fund Awards 2019. Moneywise.co.uk/investing/moneywise-fund-awards-2019.