Stocks & Shares ISA top tips

dunstonh

ruperts wrote: »

That's just because you've averaged up in a rising market though, isn't it?

If you'd have invested in a lump sum which had grown 50% in 10 years and then it dropped 30% you would have also lost almost every penny of growth.

With PCA maybe you'd lose a bit more because potentially you would be in at a higher average price. But then at the same time, you may have averaged down at some point in a falling market and end up with a similar price, or in a very volatile market you may even be in at a better average price than your lump sum. Who's to say?

I don't believe there is any inherent mathematical safeguard with investing in a lump sum beyond that which states in a generally rising market you're better of going all in as early as possible. But as we've seen with the FTSE, a simple case of poor timing could be the difference between a nice profit and still sitting on a loss after ten years or more.

For that reason I can't really see how your excel calculation works unless you are assuming a perfectly timed lump sum investment and a perfectly linear rise in the market, neither of which I'd imagine someone with your wisdom would do, so i imagine i must be wrong somewhere.

The typical economic cycle has been increasing over the decades and is not around 10 years. With a lump sum, you are invested on day 1 with all the money. So, on a 10 year timescale, you will probably see a complete cycle. With a monthly contribution, only one payment will see that 10 year investment period and half the contributions will be less than 5 years.

Increasingly, short term is no longer viewed as less than 5 years but less than 8 years for investing.

If you have a defined timescale that is only medium term (8-14 years) then and you dont have the flexibility to expand on that timescale then you run a high risk of not getting back more than you pay in. You can potentially reduce the risks of that happening by gradually changing the assets to lower risk when you get to 8 years to go. However, if you only have a 10 year term, you will, after just 2 years, need to start risk reduction.

If your timescale is longer or flexible, then you stand a greater chance of making a profit.

snowcat53

dunstonh wrote: »

With a lump sum, you are invested on day 1 with all the money. So, on a 10 year timescale, you will probably see a complete cycle. With a monthly contribution, only one payment will see that 10 year investment period and half the contributions will be less than 5 years.

Sorry but am not convinced by this at all.
Putting a lump sum in makes the timing critical - you may win big or lose big.

The usual advice is that regular contributions mitigate the risk through pound cost averaging.

dunstonh

The usual advice is that regular contributions mitigate the risk through pound cost averaging.

Pound cost averaging can reduce the risk in the short term. However, the medium term is where the risk is and pound cost averaging doesnt help you there.

We have seen two drops in excess of 40% in the 2000s - so lets use one of those as a scenario. A drop in say year 8 of 40% means that the lump sum built up suffers a 40% drop in value. However, there is just two years left for that lump sum to recover. A 40% drop needs a 67% recovery. Is a 67% gain in two years. Likely to happen? no. You may then get 2 years of buying investments cheaper but thats not long enough for them to make much of a difference. It will help but nowhere near the degree required. Chances are that the 40% drop has wiped out all earlier gains and with insufficient time to recover, the person ends up with a loss.

You could get lucky and have the 40% drop in year 4 and manage to have no significant crash for the rest of the period and do very well on it. Regular contributions over the last few years have probably never seen a better time to be made as the volatility really suits regular contributions (so those who stopped paying into regular ISAs and pensions have almost certainly lost money for the long term). However, the shorter the term, the greater the risk and the odds of failing.

Putting a lump sum in makes the timing critical - you may win big or lose big. If your 10 year cycle goes down the first 5 yr then up the lump sum is flat but with the regular contributions you have gained in the 2nd half.

We are not looking at lump sums. We are looking at regular payments. A regular payment in 10 year term stands more chance of a loss than a gain (assuming same investment from start to finish)

darkpool

dunstonh wrote: »

Pound cost averaging can reduce the risk in the short term. However, the medium term is where the risk is and pound cost averaging doesnt help you there.

We have seen two drops in excess of 40% in the 2000s - so lets use one of those as a scenario. A drop in say year 8 of 40% means that the lump sum built up suffers a 40% drop in value. However, there is just two years left for that lump sum to recover. A 40% drop needs a 67% recovery. Is a 67% gain in two years. Likely to happen? no. You may then get 2 years of buying investments cheaper but thats not long enough for them to make much of a difference. It will help but nowhere near the degree required. Chances are that the 40% drop has wiped out all earlier gains and with insufficient time to recover, the person ends up with a loss.

You could get lucky and have the 40% drop in year 4 and manage to have no significant crash for the rest of the period and do very well on it. Regular contributions over the last few years have probably never seen a better time to be made as the volatility really suits regular contributions (so those who stopped paying into regular ISAs and pensions have almost certainly lost money for the long term). However, the shorter the term, the greater the risk and the odds of failing.



We are not looking at lump sums. We are looking at regular payments. A regular payment in 10 year term stands more chance of a loss than a gain (assuming same investment from start to finish)

i think we can all dream up scenarios that shows regular contributions or lump sum is better. but at least with regular contributions you are "guaranteed" to buy shares at below the average price.

dunstonh

i think we can all dream up scenarios that shows regular contributions or lump sum is better.

You have missed the point totally if you think that was the aim. The point was showing the risks of regular contributions over a relatively short term of 10 years. Nothing to do with lump sums.

but at least with regular contributions you are "guaranteed" to buy shares at below the average price.

Since when?

jamesd

darkpool wrote: »

at least with regular contributions you are "guaranteed" to buy shares at below the average price.

No, you aren't. Not even if you add the word "some" in there.

Imagine prices varying within a 10% range for four years and then halving over the course of a year. Every purchase will have been at a higher than average price.

However, I think that dunstonh is wrong and right about the risk question that's the main point. Regular buying gets you as many investment periods as there are payments and that decrease the chance that you've bought at a high and increases the chance that some purchases will be below whatever the end value is. You lose the extra years of having much of the money invested so it is not a clear result but depends on the duration and market performance and how the longer period of possible growth of the lump sum compares with the purchase prices of the regular buying.

To some extent this is moot because most people have little practical choice but to make regular or at least not single lump sum payments.

darkpool

jamesd wrote: »

No, you aren't. Not even if you add the word "some" in there.

Imagine prices varying within a 10% range for four years and then halving over the course of a year. Every purchase will have been at a higher than average price.

it's a mathematical certainty that if you invest a fixed sum each month your average buying price is lower than the average price.

for instance say a share is 1 pound one month then 50 pence the next month - The average price is 75 pence.

if you invest 100 pounds in the first month you get 100 shares, you invest 100 pounds in the second month and get 200 shares. ie total of 300 shares bought for 200 pounds. ie average buying price of 67 pence.

pound cost averaging is a fairly good tool.

cepheus

There is an Investors chronicle article on this subject here, however are they comparing like with like?

http://www.investorschronicle.co.uk/2011/11/11/drip-feeding-vs-lump-sum-0FmfYfI2sYttnn2mzznvxM/article.html

Obviously the lump sum would yield a larger return in a rising market because the average investment over the period is higher! Surely they should be comparing the lump sum with the equivalent average investment over the drip feed period. In other words twice as much as the lump sum at the end.

A more sophisticated comparison should be comparing the drawdawn (risk) in each case as well. The less drawdawn the more you can invest for a given risk.

cepheus

Playing with my spreadsheet.

Between Jan 1994 and Jan 2009 you would have needed to invest a total by drip feeding 1.4 times that of the lump sum to get the same return on the FTSE100 index. Or to put it another way the average investment over that period would have been 0.7 times the lump sum. The maximum drawdown would be about 70% that of the lump sum.

I don't allow for dividends or charges only the index in that calculation.

jamesd

darkpool wrote: »

it's a mathematical certainty that if you invest a fixed sum each month your average buying price is lower than the average price.

That's a more likely claim. Not sure about mathematical certainty, though.