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Saving graces

The fast approaching Isa season will once again find IFAs trying to find the best-performing funds for their clients but there are other factors which could also influence potential returns.

One of the choices that clients must make is whether to invest a lump sum or regular contributions.

Lump-sum investing pays dividends in a bull market as, the more units or shares owned, the greater the exposure to an upturn. For example, an investor who put £3,600 into a fund in the all companies sector in December 1996 would have seen their investment grow to an average of £6,219 in the next three years while an investor making monthly contributions of £100 over the same period would be left with just £4,955.

But what happens in a bear market? Hargreaves Lansdown says almost the reverse is true. A lump sum of £3,600 invested in December 2000 would have fallen to £2,929 by December 2003 but the regular investor would have done significantly better with a return of £3,829.

Senior analyst Meera Patel says the figures show that clients with less to invest should not be deterred from chancing their arm on the stockmarket. “In a bear market, people are afraid to invest but they should stick with regular savings, which tend to do better. In a bull market, both types of investment make money but generally, in a bear market, only regular savings do.”

Yet despite the most savage bear market in recent history, there remains a huge skew towards lump-sum investing. Fund managers report that, if anything, it has become increasingly popular in recent years.

Regular contributions, on the other hand, have been hit by mounting household debt which has forced people to slash non-essential outgoings.

But rising debt does not completely explain the bias towards lump-sum investing – there is also psychology involved. Credit Suisse Asset Management managing director Ian Chimes suggests that investors making regular contributions are often more liable to react to market moves than their lump-sum counterparts. He says: “Investors do not understand pound-cost averaging. If markets go down, it is the monthly savers who think they are digging a bigger hole by continuing payments. They do not realise that building up units will benefit them when the market goes back up.”

Chimes says regular savers are most likely to ring CSAM&#39s helpline to demand why their investment fell the previous week. By contrast, lump-sum investors are more sanguine about short-term dips as they have a better grasp of investment fundamentals.

This educational discrepancy also extends to the Isa rules, says Chimes, which most people fail to realise permit several annual contributions into the same wrapper.

He says the smart investor puts in, say, another £1,000 each time the market tumbles, buying cheap units to ensure that the eventual upturn yields greater returns.

But M&G managing director Phil Wagstaff argues that it is lump-sum investors who fret most about short-term performance. He says: “It can be emotionally draining to try and time the investment. This is why, if the market goes down and you are a regular saver, you feel fine because you know you will be buying more units next month. There is no emotional angst there. But, the truth is, that if you think markets are going to rise in the long term, you should be putting in a lump sum if you have it and can afford to leave it invested.”

With M&G&#39s minimum monthly investment set at just £10 – compared with between £50 and £100 for most fund managers – Wagstaff says the Government should be doing more to encourage investment, particularly by stopping its gradual erosion of Isa benefits.

This is a view echoed by Chelsea Financial Services, whose client base consists less than 25 per cent of regular savers. Managing director Darius McDermott says: “The Government just amazes me. It is struggling with a huge savings shortfall and is doing nothing to get people to save.

“I think that most people are better off pound-cost averaging, bearing in mind that some of the fund groups accept tiny monthly contributions, but the Government is not helping to get the message across.”

What is the answer? With some fund firms setting a monthly minimum of just £10, most people should be able to afford saving regularly but groups are reluctant to advertise their low monthly minimums because those investors are not profitable for them.

The Government needs to do more to educate investors but judging its record, it is doubtful it ever will.

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