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 every month. Since the cost of living crisis I have had to stop my monthly contributions but I plan to start these again as soon as possible.

I don’t currently have an emergency fund but I have very kindly been gifted £10,000 by family and I want to invest this. Should I invest this all in a lump sum into my GIA or put in a set amount each month?

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

What should I do?

I have been gifted £10,000 – should I invest it in one go or put in a set amount each month?

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

Your approach will of course be dependent on your goals – are you looking to buy a house, for example, or put this money into a pension?

With a lump sum of £10,000 you could opt to invest in one go or you could invest it in smaller increments in something called cost averaging.

Lump sum investing does what it says on the tin. You put your cash into the market in one go, giving your investments exposure to the markets sooner.

There are pros and cons to this approach. If the market goes up from there you’ll stand to benefit, whereas if you invested your money over a longer period under a cost averaging approach you would then be buying shares at a higher price. 

If the market dipped after you put in the whole £10,000, though, your entire investment would go down. Under cost averaging, you could limit your losses. 

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

Savings squeeze: With inflation rising, money kept in savings accounts is losing value in real terms – so investing could be a better approach in the long term

Interest on cash left in savings accounts won’t be able to beat inflation as even the best rates are currently only paying around 5 per cent – so money left there will lose value in real terms.

Lump-sum investing certainly works if you’re comfortable with a higher level of risk. If you’re not as comfortable with this you could opt for cost-averaging, when you add the money over a longer period of time. 

This might reduce some of your anxiety as you’ll be adding a set amount to your portfolio every 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 life stage you have reached, how you meet your usual living costs, whether you have earned income or are retired, whether you have dependents etc. It may therefore be helpful initially to look at some general points.

Inflation is the persistent challenge we all face which is particularly relevant today with CPI running at 10.1 per cent. If your capital is not obtaining returns ahead of inflation then it is reducing in value in real terms. By that I mean what you can afford to buy is being reduced.

Historically one of the main asset classes to give long term returns on average that are ahead of inflation is shares. However the value of investments in shares can be volatile, rapidly going up and down.

So it is first of all important to consider what happens when investing does not work.

Investing fails if for some reason you are forced to sell your investments at a time when markets have declined. We want to consider how to invest in a way that mitigates the chance of this happening.

Reasons you might be forced to sell your investments could be if you have to raise money for an unexpected liability such as replacing a car or making up lost earnings if redundant.

With that in mind, we initially need to consider how much you should set aside as an emergency fund into accessible cash savings. I would suggest you consider what amounts to 3 months of earnings, or 3 months of living costs. 

You might also consider whether you have any potential capital expenditure coming up in the next year or two and whether to set savings aside for that also.

Considering this is a family gift, if it is treated as a potentially exempt transfer (PET), a further point may be whether you would be responsible as recipient for any potential future inheritance tax associated with the PET if the donor dies within seven years of the gift.

After allowing for the above, you could then consider investing the residue of the £10,000.

Turning to the question on investing in volatile markets and pound cost averaging, we agree with gradually feeding in the new investment over a period of perhaps six to 12 months, the aim being to reduce the chance you invest at higher or more expensive share prices.

Angharad Carrick adds: You seem set on restarting your investments which is a wise idea given the power of compounding.

Often investors get out of the market in tough times and don’t get back in until the market starts to recover. 

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

Robin has recommended building an emergency fund before starting to invest. Perhaps you could divert the £100 a month you were planning to put into investments into an emergency fund instead.

This post first appeared on Dailymail.co.uk