If you’re planning on using your stocks and shares ISA allowance before the tax year ends, then you might be wondering whether it’s better to invest a lump sum or make smaller, regular payments over time.
To address this conundrum, let’s take a look at the pros and cons of these investing strategies.
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How much can you put into a stocks and shares ISA?
For the current tax year, which ends on Tuesday 5 April, you can put up to £20,000 into a stocks and shares ISA. The allowance will remain at £20,000 for the 2022/23 tax year.
Here are five quick ISA need-to-knows:
- ISA investments stay tax free year after year.
- The ISA allowance covers you for all types of ISA.
- The ISA allowance doesn’t carry over to future tax years. If you don’t use it, you lose it.
- You can transfer your ISA to another provider without it losing its tax-free status.
- It’s possible to transfer a cash ISA to a stocks and shares ISA (or vice versa).
What are the pros and cons of investing a lump sum?
Lump-sum investing is a preferred strategy for many investors. So, let’s take a look at the pros and cons.
Pros of lump-sum investing
Lump-sum investing has two big advantages. Firstly, it gives you the fastest exposure to the stock market. In other words, after a lump sum investment, your wealth benefits from stock market returns from day one, as opposed to having a proportion of your wealth sitting in a low-interest savings account while you wait to drip-feed payments into your investment.
Secondly, lump-sum investing is the strategy that typically delivers the highest returns compared to a drip-feeding approach. This is because, according to Vanguard, the stock market goes up more than it goes down. So, if you make a lump sum payment, you’ve less chance of buying stocks at higher and higher prices, which can be the case if investing in smaller, regular increments.
Cons of lump-sum investing
The biggest concern with lump-sum investing is the risk of investing a large amount, only for the stock market to tumble soon after. If this does happen, it can be hard to stomach. It can also lead to feelings of “if only I’d waited to invest!”
This fear of regret is the reason why many investors are cautious when it comes to investing large sums all at once.
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What are the pros and cons of investing in regular increments?
Investing in smaller increments via a regular fixed payment is known as ‘pound-cost averaging’. It’s another popular way to invest and the opposite of lump-sum investing.
Pros of investing in regular increments
Perhaps the most obvious benefit of pound-cost averaging is that it can protect you from emotional regret should stocks suddenly tumble. That’s because your regular investment will continue picking up stocks every month regardless of the stock market’s recent performance.
In other words, if stocks fall, then your fixed payment will continue plodding along buying investments, but at a lower price than before. It is for this reason that a pound-cost averaging strategy can work very well during bear markets.
Cons of investing in regular increments
A pound-cost averaging strategy, most of the time, will fall short of the returns earned by lump sum investors.
To put it another way, historic data tells us that investors who invest their wealth all at once stand a better chance of earning higher returns compared to those taking a drip-feeding approach.
Do you have to invest a lump sum to use your 2021/22 ISA allowance?
With the end of the tax year less than two weeks away, you may think you have little choice but to invest a lump sum if you wish to take advantage of the 2021/22 tax-free ISA allowance.
However, this is not the case. That’s because there’s nothing stopping you from opening a stocks and shares ISA, depositing £20,000 and keeping some of this in cash within the account.
As long as you open the ISA before 5 April, you’ll be able to drip-feed in regular payments from your cash balance over the course of the year and still benefit from the 2021/22 allowance.
Are you looking to open an ISA? Whether you plan on making a lump sum investment or not, take a look at The Motley Fool’s top-rated stocks and shares ISAs to find the right account for you.
Please note that tax treatment depends on your individual circumstances and may be subject to change in the future. The content in this article is provided for information purposes only. It is not intended to be, nor does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
