Lump-sum investing vs cost averaging: which offers the highest return?

Spread, spread and spread again. As an investor, this is the mantra that is hammered into you. Spread across equities and bonds. Spread across different regions. Spread across different sectors and themes. And of course spread over time.

Not putting all your eggs in one basket certainly has its benefits. Diversification helps to reduce the risks inherent in investing. If you invest all your money in a handful of shares or a single region or sector, you may end up sustaining severe financial losses if that corner of the stock market is in turmoil. If you spread your money across a hundred different shares in different regions, sectors and themes, your investment portfolio will be more resilient to shocks.

But what about spreading over time? This also seems to be a logical and smart move. The reasoning is simple: by splitting your investment into multiple smaller amounts and investing them over months or years, you reduce the risk of entering the market when it reaches its peak. Sometimes you buy shares when they are expensive and sometimes when they are cheap. Spreading your investment over time helps to level out the average purchase price of your investments. And it gives you more peace of mind. But what does spreading your investment over time mean for your return?

Everything all at once or spread it out?

For example: Tim and Isabel are both 32 years old. They want to go on a round-the-world trip together when they are 40. Their idea is to invest rather than save money to maximise their budget. They believe this will yield a higher potential return in the long term.

Let's assume they each have 20,000 euros to invest today and they want to give their investments eight years to grow. Tim and Isabel invest in exactly the same tracker (ETF) on the MSCI World. The MSCI World is an index that tracks the performance of more than 1,400 large and mid-cap stocks in 23 countries. By choosing this tracker, Tim and Isabel think they have already spread their investment nicely: an indirect investment in 1,400 different shares is sufficient for them. Isabel invests the full amount of 20,000 euros at once. She believes this will allow her to benefit directly from the market's long-term growth and possible price increases.

Tim, however, decides to spread the risk of poorly timed investments. He divides his 20,000 euros into four parts and invests 5,000 euros every two years, regardless of whether the market is up or down at the time. He starts today with 5,000 euros. He will invest another 5,000 euros in two years, another in four years and another in six years.

Who will be the winner?

Let's say the index generates an average return of 6% per year. Even though this is less than the historical average of 8.54%, it is still a great result. How much have their investments grown by?

After eight years, Isabel has 31,876.96 euros, while Tim has 26,992.22 euros. Although they both invested 20,000 euros, Isabel now has 4,884.74 euros more in her travel budget.

This is because Isabel invested her entire amount at the start and started to build a return on the entire amount over the full eight years. Tim spread his investment, which meant some of his money didn't generate the average 6% return for quite some time.

This example shows that if you invest in the long term, it may be more advantageous to invest your money straight away rather than spread it out over time.

What do the figures say about the best approach?

Okay, you think, but that was just a hypothetical example. So let's take a look at a Vanguard study that confirms these results are not purely theoretical. Based on an analysis of the MSCI World index between 1976 and 2022, Vanguard discovered that over a period of just one year, lump-sum investments yielded a higher return than spread investments in 68% of cases. So even if you invest in the short term, you are more likely to achieve a higher return if you invest everything at once. This probability will only increase in the long term. Based on past performance (1926–2022), there is a one in four probability of losing money if you invest for one year. However, if you were to invest for 10 years, that probability falls to around one in 25, and after 20 years it even falls to zero. A lump-sum investment can yield a higher potential return because markets tend to follow an upward trend in the longer term. It also means your entire amount immediately benefits from potential market increases along with a compounding effect (when you reinvest your dividends, for example).

So what does make drip feeding attractive?

So does this make drip feeding a 'bad' choice? Not at all.

Not every investor has 20,000 euros in savings available. Drip feeding also offers benefits in terms of risk management and peace of mind. It reduces the stress of finding the “perfect entry point” and protects short-term investors from the impact of short-term declines or volatility just after making a large investment. If investors worry about market fluctuations or entering a down market, drip feeding can help them to stay invested in the long term. And that is crucial to actually benefit from an upward trend in the market. Investing – either with a lump sum or by drip feeding – is better than not investing at all. In short, your choice of strategy – a lump-sum investment, drip feeding or a combination of both – depends on your financial situation, your risk tolerance and your feelings about market fluctuations. Historically, investing a lump sum offers the best chance of a higher return. Cost averaging is a more controlled approach with fewer worries about ensuring the right entry point.

Choose your strategy yourself