We explain the advantages and disadvantages of each investment strategy.
Drip-feeding vs Lump-summing
When designing an investment portfolio, there are a lot of choices that you have to make as an investor to create an investment strategy that works for you. Calculating exactly how much you have available to invest; deciding on your investments and making sure you diversify your portfolio; figuring out your personal risk tolerance; and knowing what your goals are when you start investing are all vital elements that will form your investment strategy, making sure it has the right balance of income without more risk than you can afford.
Another one of these key decisions is choosing whether you want to invest all your cash in one lump sum or drip-feed it into the stock market piece by piece. Whether you're investing in a share account or through an ISA, there are pros and cons to using either strategy that will depend on the goals of an individual investor. Regardless of what you ultimately choose, it's important to know about both so you can make an informed decision as to which one will be best for you and your portfolio in the long term.
Drip-feeding, also known as pound-cost averaging, means putting smaller amounts of money into the market over a longer period of time. It is often considered the lower risk choice compared with lump sum investing.
A drip-feeding investment strategy allows you to turn your investing into a monthly outgoing. Regularly investing smaller sums is often more manageable and allows you to build your portfolio for the long term, ideally giving you a source of income and profit along the way.
This can be a low-cost strategy for a novice investor who might not have enough cash to fund large investments but wants to make a start towards financial freedom, especially when combined with a regular savings plan. This rewards regular savings and can help motivate you to save even more prudently, cutting back on unnecessary expenditures. To make this even easier, you could set up a Direct Debit so your money goes into your investments automatically, turning investing into one of your usual outgoings.
Creating a portfolio through drip-feeding also helps to spread out risk involved with market peaks and troughs. By making a regular investment, you're more likely to avoid market dips, or at least lower the damage this might do to your portfolio. For example, if you had £1000 to invest during a financial crisis, it would make most sense to invest it as four separate £250 investments. That way, even if your first investment falls in value, you'd have three other investments that could cover the dip.
The downside to investing on a regular basis is that returns can often be smaller than those of a well-placed lump sum as, whilst smaller sums still benefit from market rises, these upswings in value won't be as pronounced as a one-off buy.
- Often considered the lower risk choice of strategy, spreading out risk by allowing later investments to cover for any dips in the market
- Combined with a regular savings plan can turn investing into a monthly outgoing, spreading out your investing costs
- Returns are likely to be lower than a well-placed lump sum
Lump sum investing
Lump sum investing means putting larger amounts of money into the market in one go.
If you're able to finance it, investing a lump sum is an equally valid investment style to put your cash to work in the market, and can be more convenient and effective than drip-feeding. Cash sourced from things like pensions or from inheritance are common sources for a lump sum investment.
A lump sum strategy is especially valuable as it can benefit from the power of compounding. By re-investing any profit your initial investment makes, your money can continue to grow under its own momentum, without you even having to invest any more cash. This can turn your one-off payment into a self-sustaining source of income.
Larger sums also typically generate greater returns, especially if the market is low or experiencing volatility at the time you invest. This means you'll benefit from a lower share price and other undervalued investments, offering the best chances for growth on the money you've invested.
However, bear in mind that the opposite can be damaging: if you invest a lump sum right when the market peaks, that investment is going to fall as the market dips.
Another downside to a lump sum investment is that you may be waiting for a better price on a stock or fund and end up missing out entirely on the opportunity.
- Can produce impressive returns through the power of compounding
- Is a good way to make the most of market dips
- Greater exposure to risk if the market peaks as you invest
- Waiting for the best price may see you miss out on a good opportunity
To drip-feed or lump sum?
Ultimately, choosing to be a lump sum investor a drip feeder will be down to what your goals are: are you looking for profit, income or something in between? How much do you have to hand? And what is your current financial position? Once you know the answer to these questions, it's far easier to make an informed decision as to your investments.
No matter which you choose, remember that value is most often found in long term investments, which is why having an investment plan in mind is crucial. Most importantly of all, keep in mind that investments can go down as well as up, so never invest more than you can afford to lose.
All information given including prices, yields and our opinion is correct at the time of publication. Our opinions on investments can change at any time and for our latest view please go to www.share.com. To understand how our Investment research team arrive at their views please read our Investment Research Policy.