This is an important week for ISA investors. Are you a last-minute investor scrambling to use or lose your ISA allowance before the current tax year ends on 5 April? Or are you an early-bird investor with next tax year’s ISA allowance ready to invest come 6 April? Alternatively, you may be a drip-feeder who prefers to make monthly contributions given the current volatility of global stock markets.
Whatever your investing habits, the timing of your contributions can have a surprising impact on the value of your ISA over time. I’m going to take a closer look at which investing strategy would have delivered the highest returns over the last 20 years.
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How does the timing of ISA contributions impact returns?
I’ve calculated the value of an ISA pot assuming an investor has made the maximum possible contributions of £272,000 since ISAs were introduced in 1999:
- The annual growth rate is based on the MSCI World Price Return index each year (excluding income).
- The ‘early bird’ is assumed to make their contribution on the first day of each tax year and the ‘last-minute’ investor on the final day.
- The ‘drip feeder’ is assumed to make their contribution on the first day of each month, and a compound monthly growth rate based on each year’s annual growth rate has been applied.
This table shows the current value of the various investing strategies:
|
Position |
Type of investor |
ISA value |
|
1 |
The early bird |
£660,000 |
|
2 |
The drip feeder |
£644,000 |
|
3 |
The last-minute investor |
£628,000 |
All three investors would more than double their money thanks to the average growth rate of nearly 7%. The early bird wins the race with an ISA worth £32,000 more than the last-minute investor, mainly due to the power of compound growth on the ‘extra’ year’s return.
The habit of investing early in a tax year is also shared by ISA millionaires. Sarah Coles, senior personal finance analyst at Hargreaves Lansdown, comments that the millionaires “consistently invest as much as possible of their annual allowance, as early as possible in the tax year … and they’ve done this every year for decades.”
However, investing later in the tax year can have its advantages, as shown below:
|
Year |
Annual return |
Early-bird ISA |
Last-minute ISA |
|
2000 |
-16% |
£11,794 |
£12,028 |
|
2001 |
-7% |
£17,460 |
£18,174 |
|
2002 |
-28% |
£17,586 |
£20,067 |
While the early-bird ISA performed better in rising markets, the reverse was true in market downturns. The value of the last-minute ISA overtook the early-bird ISA after the fall in global stock markets from the dot-com crash. And the last-minute ISA also ‘caught up’ with the early-bird ISA in 2009-2011 after the global financial crisis.
But not everyone has the luxury of available funds to invest at the beginning of the tax year. So is drip-feeding contributions into your ISA a good compromise?
What are the merits of making monthly ISA contributions?
The drip feeder’s ISA took second place, in the middle of the values of the early bird and last-minute investor. While drip-feeding contributions on a monthly basis may sacrifice returns in a rising market, it’s a good option in falling or volatile markets.
Most investors want to buy low and sell high, but in reality, this is almost impossible to achieve. Monthly investing allows you to benefit from pound-cost averaging. When prices fall, you can buy more investments with your money.
What type of investor might drip-feeding suit? Well, Eve Maddock-Jones from Trustnet comments that, for less experienced investors, “building up their total over time” can be “more palatable, removing some of the intimidation of letting go of your entire pot in one go.”
She also points out that cautious investors may prefer this approach as a “less volatile way to invest” compared to the “gut-wrenching ride” to achieve the higher returns of the early-bird lump-sum investors.
It may also work well for investors who want to use their ISA as a monthly savings plan. Hargreaves Lansdown and Interactive Investor, two of our top-rated ISA providers, allow customers to make monthly ISA contributions from £25 upwards.
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Take away
If you have the available funds, investing a lump sum in your ISA at the beginning of the tax year “gives you the advantage of time, which is always the most precious commodity” according to financial advisory firm FAS. They advise that “Using your ISA allowance early can make a real difference to the returns on your investment.”
However, they also rate monthly investing as “a simple way of taking the guesswork out of investing, avoiding uncomfortable market highs and lows.” Given the current market volatility, monthly drip-feeding could be a good strategy for a wide range of investors over the next few years.
