New research from wealth manager Architas has found that the best way for savers to take advantage of the current bull market is to invest in an Isa as soon as possible.
Architas analysed returns on Isa allowances invested into the FTSE 100 at the start of the tax year from 2006 to 2016, compared with allowances invested at the end of each tax year, when most investors tend to get around to it.
It found that, investing the full allowance early on returned a total of £4,008 more over the decade than when investing was left to the last minute. The analysis was based on FTSE 100 total returns investments, excluding charges.
Here’s why investing your full Isa allowance generates bigger returns:
- Bull markets favour early bird investors, as they get in when markets are lower
- Those who invest at the start of the tax year benefit from an extra year’s dividends
- Dividends reinvested during the year also generate growth throughout the year.
Explaining that early investors "get more exposure to a rising market," Adrian Lowcock, investment director at Architas says: "With Isa allowances set to rise significantly in the 2017/18 tax year, should markets remain favourable, we could see this trend [of early bird investments producing higher returns] continue."
He adds, "overall it is good to be early, but time in the market matters more than timing the market. So whether you are an early bird or last-minute investor, you should benefit from staying invested over the longer term."
Ealry-bird investing does have its risks
What should investors do in a less buoyant market? Lowcock says: "Early-bird investing really works wonders in a rising market, but if the market falls it is less effective - and in the short term investors would suffer. The challenge in these situations is that it’s very difficult to know exactly when a market has reached a bottom or indeed a peak."
He adds: "Over the longer term markets do tend to rise and falling markets tend to be short-lived in comparison."
What to do if you can’t afford to invest a lump sum early on
Investing the full allowance at the start of the year isn’t something that every saver can do. In this case, ‘drip-feeding’ can help to enhance returns. It also sidesteps the risk of investing a single lump sum directly before a market fall.
Drip-feeding capitalises on what is known as pound cost averaging. When share prices are low, your regular monthly payment buys more shares or units than it would otherwise. When share prices are high, your monthly payment will buy fewer shares or units.
As a result, you are likely to find that you end up owning more units overall than you do if you plough all your cash into the market at the start of the tax year. While this is useful for savers who wish to put away a portion of their salary each month, this strategy means that you will only receive dividends from whatever money you had in the market when they are paid, rather than a full year's worth.
This story was originally written for our sister magazone, Money Observer.