If ever you have the good fortune to receive a windfall due to an inheritance, bonus payment or property/business sale, you will know that one of the big questions is how to invest the cash.

Should you invest all of it at once or should you ‘pound-cost-average’ by breaking the lump sum into smaller chunks and investing them over a longer period of time?

It’s a dilemma that should not be confused with regular saving, which is when a pre-defined amount of money leaves your bank account each month and purchases however-many fund units are possible at the fund’s prevailing price, so that your average fund-unit cost changes over time.

That’s unquestionably a positive form of ‘pound-cost averaging’ because by effectively outsourcing your investments to a pre-programmed financial transaction, you don’t have to worry about market timing and have a manageable and disciplined plan to help grow your wealth. Here, each individual monthly payment represents its own individual lump sum.

But what about when you’re presented with a large lump sum and you have the choice to invest in one go or to spread it out? What do you do then?

To work out which strategy would be best, we’ve compared the performance of cost averaging and lump-sum investments across various markets, time periods and return assumptions. We also did it in a range of different currencies, including pounds.

The findings of our research team1 are unequivocal: Lump-sum investment strategies tend to beat cost-averaging strategies about two-thirds of the time.

The historical evidence

Using an index as a proxy2, our experts Megan Finlay and Josef Zorn looked at the performance of global stock markets between 1976 and 2022 and contrasted the fortunes of a lump-sum investment versus various pound-cost averaging investment strategies on a rolling one-year basis.

What they found, as the table below shows, is that the more spread out the investments and the less time a portfolio is fully invested, the higher the percentage win, or ‘hit ratio’, of a lump-sum strategy.

So much so, that when an investment was split into six monthly payments, the win ratio for the lump-sum strategy rose to almost 71%.

It’s a historical trend that’s discernable too when we look at just the UK stock market, as the table also shows.

Percentage of times lump-sum investing beats different pound-cost averaging strategies

                        Market
Pound-cost averaging period                              

Global

UK
Three months

67.8%

68.1%
Four months 68.9% 69.8%
Five months 69.7%

70.2%

Six months 70.8% 69.5%

Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

Source: Vanguard. Notes: Hit ratio is defined as the outperformance of one strategy against the other after a one-year investment period in British pound terms. One-year rolling investment performance compares lump sum against cost averaging. Our base case for cost averaging is the three-month split, meaning splitting the investment into three equal parts and investing each one month apart. Markets are represented by the FTSE All-Share Index in the case of the UK (1986-2022) and the MSCI World Index in the case of global markets (1976–2022).

In most cases, our researchers found that the less time fully invested, the less the potential to maximise investment returns.

In short, since lump-sum investing outperforms on average, you are usually better off investing immediately instead of holding back a portion of the potential investment.

What difference could it make in your wealth?

How might this observable difference in performance translate in monetary terms? The answer is it really depends on how markets perform in practice – on factors beyond an investor’s control – since markets can go down as well as up, which means you could potentially get back less than you invested.

What we can say, nonetheless, is that in most cases, based on the historical evidence, investing a lump sum straight away is significantly more likely to grow your wealth than cost averaging. That’s illustrated by the chart below which shows how a portfolio might have grown over a one- year period at any point between 1976 and the end of 2022.

Although the data here is in US dollars (we start with a portfolio of $100,000), we would expect to see a similar pattern in pounds, given the ‘hit ratios’ shown earlier.

What can be observed is how in at least 75 out of every 100 scenarios measured during this period3, the lump-sum approach would have grown the investor’s portfolio by more than would have been the case if their investments had been spread over three months. This remained true regardless of whether the money was invested in a 100% shares portfolio or in portfolios split 60/40 and 40/60 between shares and bonds.

Historical wealth ranges for lump-sum versus cost-averaging strategies after a one-year investment period

 

100% equity

60% equity / 40% bonds

40% equity/60% bonds

Percentile  

Lump-sum Cost averaging  Lump-sum Cost averaging Lump-sum  Cost-averaging
95th

$139,453

$131,012

$127,631

$121,967

$122,673

$118,303

75th 119,063 116,286

113,661

111,545

111,686

109,640

50th 111,940 109,580

109,360

107,453

107,648

106,400

25th 102,070 101,531

104,082

103,134

104,420

103,290

5th 82,947 85,906

92,720

94,043

97,144

97,701

Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

Source: Vanguard. Notes: This figure is for illustrative purposes only and does not represent any particular investment. Percentiles are for a one-year rolling investment period with a starting wealth of $100,000 for each of three portfolios (100% equity, 60% equity/40% bonds, and 40% equity/60% bonds) using a lump-sum strategy versus a three-month cost averaging split (splitting a lump sum into three equal parts and investing each one a month apart). Calculations are made using MSCI World Index and Bloomberg US Aggregate Bond Index returns for 1976–2022.

It should be stressed that the performance data above excludes costs and is just for illustrative purposes. The observable trend, nonetheless, is clear.

So, when there’s a choice to be had, remember that lump-sum investing holds a distinct edge over pound-cost averaging. 

Still, as shown in the lowest 5th percentile of market performances during the study period – the bottom row of the table – lump-sum investing can initially hurt your wealth more than cost averaging if you happen to be particularly unlucky with your timing and invest during a downturn.

It’s why, for more cautious and loss-averse investors, pound-cost averaging a lump sum rather than investing it all at once can still play a useful role by shielding you from the possibility of regret, even if reduces your returns in the long run, as the evidence would suggest.

Investing a lump sum gradually is also better than not investing at all since pound-cost averaging, our experts found, has historically performed better than if you just stuck with cash4.

 

 

1 Megan Finlay and Josef Zorn, Ph.D., CFP®, ‘Cost averaging: Invest now or temporarily hold your cash’, Vanguard Research, February 2023.

2 In this case, the MSCI World Index.

3 10,000 different simulations were run in all.

4 In their study, [KD2] Finlay and Zorn found it outperformed cash 69% of the time. Outperformance is based on comparing wealth after a one-year investment horizon with a three-month cost averaging split (splitting a lump sum into three equal parts and investing each one a month apart) and after a cash-only strategy using the 3-month US Treasury bill rate as a proxy.

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The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

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