Dubai: When it comes to putting your savings to work, you could either invest it as a lump sum or by putting in money, gradually, over time. But which is best, and what should new investors think about when deciding between the two? UAE veteran investors shed light on this widely debated topic.
“Over short timeframes, it tends to make less of a difference whether you invest a lump sum or split it into regular amounts, but as time goes on the perks of putting money to work at the earliest chance you get tends to have more of an effect,” said Mohammad Shaan, a Dubai-based wealth advisor.
“For long-term, periodical investing is a good option, as it allows you to benefit from ‘cost averaging’. If you are investing for the short term, lump sum investing may be more suitable. For risk-averse investors, periodical investing is better, as it helps you average out market fluctuations.”
Periodic investing means automatically investing an amount of money at regular intervals, otherwise referred to as Systematic Investment Plans (SIPs). “SIPs are ideal for beginner investors to gradually accumulate a tidy amount of capital, as it takes place automatically,” Shaan added.
SIPs make use of a long-term investment strategy, ‘cost averaging’, which is investing in risky investments like stocks at regular intervals with the goal of benefitting from spreading out purchases. This averages your cost of investing and reduces the risk of being affected by stock market volatility.
Why SIPs are preferred more among newbie investors?
“Most new investors do not have large sums to invest and don’t always know where to begin. Typically, as their earning power increases, they will have spare cash each month to allocate to their investment portfolio,” said Brody Dunn, an investment manager at a UAE-based asset advisory firm.
“This is why the ‘cost averaging’ investment strategy is ideal for new investors looking to build a long-term portfolio. It also provides for a very hands-off approach, which can be ideal for the inexperienced investor.”
However, this does not imply that newbie investors are averse to putting their money in lump sums. The ‘lump sum’ method is equally popular with some investors inclined to push in a large capital during extreme market downturns or a prolonged period of decline. Here’s why.
Does it help to invest a lump sum amount all at once?
“When investing a portion of your money in one go, there are rewards and risks to that choice. It's a decision that can cause anxiety and even lead to losses in the short term,” added Shaan. “But, despite the risk, the numbers suggest that lump sum investing can be a shrewd choice for long-term investors.
“This approach can especially be advantageous for those seeking to capitalise on market fluctuations. During market downturns, lump sum investors can acquire shares at reduced prices, potentially yielding greater long-term returns.”
However, lump sum investments come with inherent risks. Sudden market declines following the investment could result in losses. Moreover, a high-risk tolerance is essential for lump sum investors, given the need to effectively time the market.
1. Investment amount: If you have limited funds, you may favour SIPs as this allows your investments to grow at a gradual pace.
2. Investment horizon: For long-term goals, SIPs often outshine, as they help spread the investment's cost across time.
3. Risk tolerance: Risk-averse investors may lean towards lump sum investments, profiting when potentially entering the stock market at lower prices.
4. Market conditions: In times of market volatility, lump sum investments hold advantages with investments getting possibly cheaper.
In the end, the choice between investing periodically and lump sum is dependent on individual circumstances and the state of their finances. So, a thorough check of financial aspirations is crucial before reaching an investment decision. But which is a more profitable method?
“As a general rule, lump-sum investing may give you higher returns annually than a ‘cost averaging’ strategy like SIP. However, ‘cost averaging’ or SIPs reduces initial risk of ‘market timing’, which can appeal to those seeking to minimise short-term losses and 'regret risk',” added Dunn.
‘Regret risk’ is the risk of investors feeling regret if a wrong investment decision is made and will thereby consider this regret when making investment decisions in the future. This can alter an investor's risk profile, causing them to be more risk-averse or risk-seeking than normal.
“The reason why lump sums can return more than monthly investing is simple – our cash is simply spending more time in the market, earning returns upon returns. As the saying goes: it's time in the market, not timing the market.”
However, if you do not have a lump sum amount to invest currently, or do not feel safe doing so, the next best option is to make use of ‘cost averaging’ strategy like SIP. Even though it may be less rewarding than investing a portion of your savings all at once as a lump sum, bear in mind that you are still putting your money to work, which takes priority.