Choosing Between Lump Sum and Regular Savings

In the CII R06 or AF5 exams, one question that often pops up is the consideration of whether it’s better to invest a lump sum or save regularly for a future investment goal or for retirement. In this blog post, we consider the pros and cons of each method.

This article is relevant to the 2023/24 examinable tax year and is correct as at 8 August 2023.

Regular Savings

For those who don’t already have a lump sum, regular savings is a great way to start setting aside money for future goals.

Benefits include:

• Savings discipline: using direct debit, for example, means money automatically gets invested regularly, creating a good savings habit with minimal effort required from the saver.
• Avoids market timing issues: with a lump sum, if the market falls shortly after investing, there’s the immediate danger of a large paper loss.
• Volatility upside: by investing regularly, the peaks and troughs of market volatility even out over time. Pound cost averaging works in favour of the client, evening out purchase costs; when prices are low, more units are bought increasing the value of the investment over time once prices rise again.
• Spreads cost: clients can start with low monthly payments so they become part of their usual pattern of expenditure.
• Flexible payments: should affordability become an issue, payments can usually be paused or stopped.
• Payments can increase over time: clients can build in automatic annual increases so that savings or pension contributions can keep pace with inflation.

On the downside, regular savers need to monitor their general spending to ensure that they have enough funds to cover their regular contributions. In addition, there’s a danger that they might set their monthly contributions too low and be missing out on valuable tax reliefs, as well as tax-efficient income and growth.

Lump Sum

Investing a lump sum may enable clients to reach their future goals sooner, especially where the money is invested in a pension, meaning the contribution is boosted by tax relief.

In addition, if they receive lump sums on an ad-hoc basis, for example, if they’re self-employed or receive bonuses, investing lump sums may be more realistic than regular savings.

However, there are some downsides when it comes to the practicalities of lump sum investing:

• Requires action: investing a lump sum takes time and requires the investor to take action. For those with busy lives or who are prone to procrastination, finding the time to make the investment may be an issue.
• Market timing: as mentioned above, investing a lump sum prior to a stock market crash can result in an immediate loss, albeit only on paper, assuming the investment is for the long term. In addition, there’s no way of benefiting from pound cost averaging.
• Changing priorities: where a lump sum is available, there may well be competing priorities for its use. Generally, people tend to put off investing for the future and focus on more immediate goals such as holidays and home improvements.

It should also be remembered that lump sums into both ISAs and pensions are subject to annual limits: £20,000 for ISAs and £60,000 for pensions (unless tapering or the money purchase annual allowance apply; in which case the pension contribution could be limited to as little as £10,000).

Arguably, what matters most is that sums are being set aside for the future, whether that be on a regular or lump sum basis. Both methods have pros and cons of which clients should be aware so that they can make an informed choice on the best route for them.

Grab the resources you need!

If you’re studying for your CII R06 exam, and you’re wanting to feel more confident on exam day, grab our free taster analysis to try out one of Brand Financial Training’s resources for yourself.  Click the link to download the R06 case study analysis taster now!