Riding out market volatility: Lump sum versus regular investing
The past few years have been something of a rollercoaster for investors, with financial market volatility at its highest level since the 2008 global financial crisis.
The coronavirus pandemic promoted a sharp sell-off in global equity markets in early 2020. But unprecedented stimulus from governments and central banks and optimism over a vaccine for COVID-19 boosted stocks, helping the MSCI World Index end the year 15.9% higher.1
Investors subsequently endured another topsy-turvy year in 2021 but one that ultimately helped cement the recovery from pandemic-driven lockdowns in most major markets, as the MSCI World delivered a 21.8% gain over the year.
However, what looked like a potentially calmer start to 2022 gave way to renewed volatility as Russia invaded Ukraine, oil prices soared while central banks started tightening monetary policy in the face of record inflation.
Volatility index spikes
We have developed a proprietary turbulence index, which tracks the evolution of parameters based on volatility and correlation - if the measure jumps sharply, it implies that the market is entering a risk-off mood. Our data goes back more than 20 years, to the start of 2000, and allows us to analyse market sentiment over that time.
Unsurprisingly, in March 2020 after coronavirus was declared a global pandemic, investors endured a period of heavy volatility, with the index hitting 88.44, a level not reached since the 2008 financial crisis.
However, throughout 2021, volatility remained relatively benign with our index in single-digit territory for 41 weeks of the year. That was despite ongoing concerns over the path of the pandemic and economic recovery, coupled with inflation at historic highs, and other events that rattled markets in the short-term, such as the US Presidential election and former Donald Trump’s refusal to concede defeat.
More recently, Russia’s invasion of Ukraine at the beginning of March prompted our turbulence index to jump to 21.65 from 8.79 the week before – underlining the extent to which volatility can spike almost overnight.
Lump sum or regular investing?
One question many investors have during periods of market volatility is when to invest. But attempting to time the market is a risky strategy as investors who delay putting their capital to work in the hope that prices will fall further, or who sell in the hope that they will be able to buy again at the bottom of the cycle, risk missing out on some of the potentially best gains.
For example - and while past performance should not be viewed as a guide to future returns - if an investor put $1,000 into the MSCI World Index 40 years ago, they would since have seen that lump sum grow to $22,039, equivalent to an annualised total return of 7.8%, as at end December 2021. However, if they missed just five of the best days over that period, their annualised return would have been 6.7%, leaving them with a far lower $14,931.2
In our view, rather than trying to find the best possible entry point, drip-feeding money into the market on a regular basis is a sensible option for many investors.
Of course, you could invest a lump sum. By taking this route, it means your money will be put to work immediately, so you’ll benefit from any price increases. But equally, you’ll also be exposed to any downward movements, so if prices drop soon after you invest, your investment will fall in value too. For example, anyone who invested in global equities at the start of 2020 would have quickly felt the brunt of the market falls during the early months of the pandemic.
However, by investing regularly, it means you don’t have to face the decision of working out exactly when you should invest and trying to ‘time the market’. Instead, your money will go into the market every month, regardless of whether prices are falling or rising.
The draw of pound-cost averaging
By drip-feeding money into the market, it means you potentially benefit from ‘pound-cost averaging’, which helps to smooth out investment returns over time, as this means you purchase more shares when prices are low, and less when they are expensive.
Therefore, over time, you’ll end up paying the average price during that period, helping smooth out market volatility. As such, for investors with a long-term perspective, who are investing regularly, volatility can even be a potential advantage.
For example, if you invested €100 a month over a 10-month period in a fund. If the portfolio’s unit price is €10 in the first month, your €100 investment would buy you 10 shares.
If the price dropped to €7 for the next five months, your same investment would buy you 14 shares in each of these months. If it subsequently rose to €12 for the remaining four months, the same €100 investment would only buy you eight shares in each of these months.
In total, you’d end up buying 112 shares over the 10-month period if you invested €100 a month. If, however, you’d invested a lump sum of €1,000 at the start of the 10-month period when the share price was €10, you’d have 100 shares.3
Assuming the share price recovered to €10 at the end of the 10 months, your lump sum investment would still be worth €1,000, whereas if you’d invested regularly, your 112 shares would be worth €1,120, leaving you €120 better off.
Of course, the reverse could happen, and if share prices rose over the same period, your monthly investment would buy you fewer shares, leaving you worse off at the end. Whichever approach you take, bear in mind that no-one knows when the best time to invest will be - but committing to investing over the long term will give your money the best possible chance to grow.
Investing for the long term
While there have been over 11.25 billion vaccine doses administered4 against COVID-19, cases of the virus are on the rise again in some countries and new lockdowns – such as in China in March/April 2022, which saw millions confined to their homes once again – can have a significant impact on global financial markets, as business activity is restricted or halted causing economies to potentially contract.5
And geopolitical issues have flared up with unwelcome frequency over the past few years, from the US/China trade war to Russia’s invasion of Ukraine, demonstrating the extent to which volatility can swiftly return.
Consider too that asset classes tend to be more correlated during periods of market uncertainty, which only serves to add to the instability.
No asset class is going to win out all the time, so by diversifying across multiple asset classes and sources of potential investment returns it means you should hopefully be suitably prepared for any market wobbles, whenever they arise.
For investors with a long-term approach, regular investments can potentially help them ride out periods of market volatility – and perhaps even mean price fluctuations work in their favour.