You may have had lots of resolutions this year – many of which you have broken already. So here’s one that, once started, should be relatively pain free and easy to keep. Save regularly into your individual savings account (ISA).

The benefits of saving regularly are not just a sales pitch on the part of ISA providers to make sure we keep investing. The advantages are bound up in the principle of what is called ‘pound-cost averaging’. This means the peaks and troughs of stock market fluctuations will be ironed out or smoothed over as a result of investing regularly over a long period.

You won’t be putting all your money into the market when it is at a peak. Neither, of course, will you be putting it all in when the market is low – but for many investors that is not something they would rush to do. The way to look at it is that you can buy more units with a fund when stock market prices are low and fewer when prices are high and, in this way, you make the volatility of the stock market work to your advantage. It also ensures that you have a permanent interest in the equity markets, rather than trying to time your investments – a strategy that most investment professionals regard as impossible.

The numbers add up
To demonstrate what regular saving into the stock market can achieve, according to figures provided by Lipper, if you had invested £20 per month in the average UK All Companies investment fund savings plan ten years ago (figures to 31 December 2007) you would have an investment pot of £3,379.52. This compared with the £2,524.73 you would have had if you had invested into a building society account. Over 20 years
it gets better still. If investment had continued into the investment fund, the pot would be worth £13,541.59 compared with £6,023.56 within a building society account.

Pound-cost averaging will even out any short-term volatility in the market, says Sally Collins, senior investment adviser at IFA Bestinvest. She concedes, however, ‘That can also work against you. If markets consistently go up over a two-year period and you are investing in the funds in a particular sector and are buying in at a higher price each month then you can be disadvantaged. The fact of the matter is that with most markets, and most sectors, funds go up and down over their lifetime, so pound-cost averaging can help even that out.’

Anna Bowes, investment manager at AWD Chase de Vere, agrees that if the stock market has taken a particular tumble, then making regular savings is a very useful way of enabling investors to avoid the perpetual buying high and selling low issue. She argues that it is important not to let your resolve wobble just because the stock markets are.

‘What people fear is the stock market falling and then they don’t want to invest. In fact, they want to cash their savings in,’ says Bowes. ‘You really mustn’t do that. The thing to do would be to invest a bit more, but people are naturally averse to that in case the market falls further.’

Positive benefits
While one could potentially argue that investing regularly will result in returns that are no better than average because you are buying some units within a fund when stock markets are down and some when the stock markets have gone up, Bowes counters that this could be considered a positive strategy.

‘You may be always hoping stock markets are going to fall when you are doing regular savings. But that is the nice thing about investing in this way: it is a win-win situation. If the stock market goes down then you are buying more units every month; if the stock market goes up then the units you have bought are going up in value,’ she says.
Most of us assume that regular saving means investing each month, and usually the same amount. Most fund providers will have regular savings plans that allow investments from as little as £20 per month, although £50 is a more typical figure. There is no compulsion to lock into saving every month – you can choose other regular periods in which to invest.

‘It is completely up to the individual investor,’ says Collins. ‘The more cautious investor would probably choose to invest on a month-by-month basis because the pound-cost averaging effect is spread out over a larger number of sums being invested. If the client prefers to do it on a six-monthly basis, that is possible but the logistics are harder, so with most ISA providers you set up a monthly direct debit with a chosen option to invest every three or six months.’

She adds, ‘The potential problem here is that the client will have to remember to send in a lump sum cheque every three months or six month, as opposed to direct debit where you don’t have to worry about it because it is going out of your bank account on a set date. If you have to save up to get that £200 or whatever every three or six months then you have longer to go off and spend it elsewhere.’

Psychological attractions
This, of course, hits the nub of the other advantage of making regular savings – call it psychological if you will – that investors can relax knowing they are automatically investing each month and don’t have the temptation of doing something else with that sum of excess cash washing around the current account.

With advisers and providers often expounding the benefits of regular saving, does this mean the lump sum investment approach should be avoided? Not necessarily.
‘At the moment, markets have been so volatile and unpredictable that the arguments for pound-cost averaging are at the forefront of most people’s minds, because it is impossible to pick when you go into a market or come out of it,’ says Amanda Davidson, director of IFA Baigrie Davies. ‘Clients often ask if they should put a lump sum in or save regular amounts, and you can never say whether one is going to be better or not. The advice I give is: pay as it suits you to pay.’

Davidson sympathises with clients who often have disposable monthly income, but know how easy it is for that income to be frittered away as part of general household expenditure. It makes sense in those circumstances to commit to invest regularly, she says.

‘If investors leave it to the last minute, the chances are they won’t have the full £7,000 they are entitled to put into an ISA this year, which is more tax efficient than many other forms of saving.’

The option to invest a lump sum can still run alongside a commitment to invest regularly. If, for example, you have reached the end of the tax year and haven’t put the full amount into your ISA, you can then top up with a lump sum. The key message is not to lose out on your tax-free allowance, because once it’s gone, it’s gone.

Maximising tax-free holdings
‘If at this stage you have not put anything into your ISA, stack it up for this year,’ Davidson advises, ‘because then you leave next year’s allowance free. We still have a couple of months left of the current tax year, so you could split your £7,000 into the months that are left to April. You can invest, therefore, lump sums but still as if they were regular savings. If you leave it too late, there is no margin for error and you could lose the opportunity for tax-free savings for that year.’

As for where to invest on a regular basis, just as with any other investment decision it will depend on what investments are held elsewhere within your portfolio.
‘If you are 100 per cent in UK equities, you need to be thinking about diversifying from the UK or that one particular sector,’ Collins advises. ‘Whether you are investing £50 per month or a lump sum of £1 million, you have to consider your objectives, how much risk you are happy to take and how long you want to tie up your investments. By comparing your current assets with a standard asset model you can build up a balanced portfolio.’

A degree of flexibility
Regular saving into an ISA need not mean you are locked into a fund or restricted as to where you invest for the year. You can invest in more than one area with your money. ‘Even with £100 a month, you could probably split that between two funds and have maybe a global fund and a UK fund to give you a bit of a spread,’ says Davidson. ‘And you can chop and change funds so you might choose to pay into a couple of funds for the first six months and another couple for the next six months.’

Anna Bowes points out, ‘Regular saving takes away the worry of market timing, but it doesn’t necessarily mean that you are going to do better than you potentially could if you had invested a lump sum. It depends on how long you saved for and what happens to the stock market in the meantime. And as we don’t know what is going to happen in the future, there is no right or wrong answer as to whether lump sum or regular saving will produce the better overall return.’