Earn £947 more from your ISA

Find out how to give a huge boost to your ISA return this month - and every month - for the rest of the year.

Last week, I explained why it’s important to invest your ISA allowance as early as possible in Act now or lose £714 this year. By investing at the beginning of the tax year, rather than towards the end, you can take advantage of an extra year of tax-free growth.

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Luckily that’s not the major problem it might appear because drip feeding your ISA month by month instead of investing a lump sum can actually give your investment an unexpected boost.

You might assume that a lump sum invested at the beginning of the tax year will always grow faster than smaller amounts drip fed into your ISA over time. But, under certain circumstances, it’s possible to achieve a better return with monthly instalments.  

What is pound cost averaging?

By investing money in your ISA on a monthly basis, you can take advantage of what’s known as ‘pound cost averaging'. Pound cost averaging allows you to make the most of upturns in the market while softening the downturns.

Let’s imagine you contribute £850 a month into your stocks and shares ISA starting this month, and that money will be put into an investment fund of your choice. By the end of the tax year you would have invested the full £10,200 allowance.

• Watch our How to invest your first stocks and shares ISA video.

Note that if you’re putting your money in an investment fund - which is what many stocks and shares ISA investors do - it will be used to buy units in the fund, rather than purchasing shares directly.

Each contribution you make will buy units at a range of different prices as the market fluctuates from month to month. When the market rises you’ll purchase fewer shares with your £850, but on the other hand, when the market falls you’ll buy more shares with the same £850 contribution.

So that’s simple enough. But what’s interesting about pound cost averaging is that over any period, the average price paid for your units will always be lower than the average market price - no matter whether the market is experiencing strong growth or collapsing.

How does pound cost averaging work?

Let’s take a look at how pound cost averaging might work in practice. The table below shows the fluctuating unit price and the number of units bought each month with an £850 monthly contribution:

Source: Fidelity International.

By the end of the year you would have invested a total of £10,200 (£850 x 12) and purchased 1,114.73 units. That means the average unit price you have paid is £9.15. But as you can see from the table, the average market unit price is £10. So by drip feeding your investment, you have saved 85p per unit and boosted your investment simply because of pound cost averaging.

Is investing regularly better than investing a lump sum?

Even better, pound cost averaging could actually help a regular investment return more than a single investment.

Using the same example shown above we’ve already seen that after one year a regular investor has bought 1,114.73 units. But a single lump sum investor who invests the full £10,200 allowance in month 1 - when the unit price was £10 - will only have 1,020 units. The table below shows the effect this would have on the final value after a year:

Monthly investing versus a lump sum

Source: Fidelity International.

In this example, the unit price is the same at the beginning and end of the investment term. So that means, despite the fluctuations in the unit price, the lump sum investment is worth the same amount of £10,200 after a year. But the monthly investment has increased to £11,147.30 over the same period - beating the lump sum investor by £947.30.

Of course, there’s no guarantee that pound cost averaging will always produce better returns than a single investment, particularly if it’s invested when the market is very low. But this involves timing your investment correctly - and we all know how impossibly difficult that is.

So a regular investment won’t always beat a lump sum, but it’s a very good reason not to feel too disheartened if you can’t invest the full ISA allowance this month.

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