Regular investing softens impact of crash

While the first half of the year was generally uneventful for UK markets, this changed last week. The FTSE 100 experienced sharp falls amid growing concerns about the global economy in the context of European and US debt worries.

This has set the tone for markets this week too, with more sharp falls. For some investment company managers, this is something of a long-overdue reality check.

Bruce Stout, manager of the highly rated Murray International Trust, commented: "Events and newsflow of the past few weeks have hopefully at last brought home how critical the situation is in the UK, across Europe and in the US."

"There is no quick fix to the years of debt-fuelled spending by both government and the consumer and as such investors should brace themselves for years of sub-optimal growth caused by the stringent austerity measures required. Fortunately there are parts of the world, particularly Asia and Latin America, which are in much better financial health."

There is a broad spectrum of views amongst fund managers, and there are always opportunities to be had. Neil Woodford, who manages Edinburgh Investment Trust, recently said: "The most attractive valuation opportunities exist in companies that are best placed to navigate the economic headwinds and the on-going fallout from the banking crisis."

"The most dependable, resilient businesses in the market are currently trading on ludicrously cheap valuations despite their proven ability to sustain and grow dividends. These areas include pharmaceuticals, tobacco and telecoms."

Given the market volatility, where does all this uncertainty leave private investors? Is it time to drip-feed money into the market, sit tight, or take advantage of cheaper valuations by investing a lump sum? While we have no idea where markets may take us from here, the AIC has compared regular versus lump sum investing over different periods, including recent bear markets.

We looked at the last bear market of 30 September 2007 to 28 February 2009 and 29 February 2000 to 31 October 2002 and in each instance, regular investing does better than the equivalent lump sum. However, over the longer-term, lump sum investing has historically always outperformed.

In the last bear market (30 September 2007 to 28 February 2009), a regular investment of £50 per month into the average investment company would have seen a 33 per cent loss in share price total return terms. While this is a significant loss, the equivalent lump sum investment would have lost 44 per cent – some 10 per cent more.

Crucially, if regular investors had continued investing £50 per month until the end of 2009, thereby benefiting from the rally in markets in the second half of that year, regular investors’ losses would have turned into a 9 per cent gain, whereas lump-sum investors who stayed in the market until the end of December 2009 would still be nursing a 16 per cent loss.

Not only does this illustrate the advantages of "sitting tight", but also how regular investing can be a useful tool during turbulent times.

Looking back to the bear market of 29 February 2000 to 31 October 2002, investors would have also lost money through both regular and lump-sum investing, but again losses were reduced through regular investing. Regular investors investing £50 per month in the average investment company would have made a 30 per cent loss in share price total returns, whereas the equivalent lump sum investment would have lost 37 per cent.

Clearly, regular investing can help smooth out at least some of the highs and lows in the price of shares. Known as pound-cost averaging, it means investors buy fewer shares when prices are high and more when prices are low.

However, illustrating the old adage that "fortune favours the brave", over the longer-term, lump-sum investing has always outperformed regular investing.

Over 10 years, a £50 per month investment in the average investment company to 30 June 2011 has grown to £10,057, whereas the same amount invested as a lump sum (£6,000) over the same time frame has almost doubled, to £11,855.

Over longer periods the difference is greater still: over 18 years to 30 June 2011, £50 per month in the average investment company has grown to £23,645, but the equivalent lump sum (£10,800) has grown to £46,656.

The decision on how to invest has to come down to investors' individual risk profiles. Clearly over the long-term, lump sum investors will benefit from the effects of more money working on their behalf. However, for those who agree that the market’s reality check is long overdue, and who think the debt hangover has some way to run, regular investing may well be worth considering.

Annabel Brodie-Smith is director of communications at the AIC. The views expressed here are her own.