One-off investment vs. cost-average effect – the right return

The debate as to whether it makes sense for investors to make a large one-off investment or to invest piecemeal on a monthly basis is almost as old as the stock market itself! The cost-average effect means that you end up with an average price due to the fluctuating share prices. But where is the risk of incurring losses higher? And which type of investment promises a higher return? I want to find out together with you!

The practical test: how the cost-average effect performs on the stock market!

An example: Imagine you have exactly €6,000 available at the beginning of 2020 and want to invest it in the iShares Core MSCI World ETF. With a one-off investment, you invest the entire amount in the ETF directly on the first trading day of the year – at a price of €56.70.

The other option: You invest €500 in the ETF every month for 12 months. In January, you also buy at a price of €56.70. However, the ETF fluctuates strongly throughout the year, and you buy shares in the ETF at a price of just €44.24 during the coronavirus crash.

At the end of the year, your fragmented saving has paid off: thanks to the cost-average effect, you bought an annual average of just €53.86 worth of units – so you saved €3 per unit! This is also reflected in the return: where you bought 105.82 units in the one-off investment and made a return of 13.93%, your distributed investment at the end of the year shows 112.04 units and a return of 20.63% on paper! So it was worth distributing!

But that’s not always the case! The cost-average effect only pays off in falling markets, in our example the coronavirus crash in spring 2020. If markets move sideways or rise, the effect is reversed. Another example: I invest the same amount of €6,000 in the iShares Core MSCI World ETF, but this time in April 2021. When I make my one-off purchase, the price is €44.24 – and continues to rise the entire time! As a result, the average value of a distributed investment after 12 months is significantly higher, at around €55!

It becomes even clearer with the final return: where distributed investing ends up with a (still good) value of €7082.74 with a return of 18.05%, my one-off investment has really paid off: a value of €8761.30 and a return of 46.02% are top-notch!

To summarise: With the right timing, you can often get more return out of our investment with a one-off investment! The mostly rising stock market prices over the last 100 years are also a good indicator that a one-off investment often pays off more!

Return and risk: What is your risk tolerance?

The practical example has shown that utilising the cost-average effect is not always worthwhile! But what does it actually look like from a historical perspective? A chart of the S&P 500 from 1960 to 2020 shows: Wherever the graph is above 0%, a piecemeal investment has paid off more; wherever it is below, a one-off investment would have made more sense. Long story short: In most cases, a one-off investment made more sense! More precisely, in 74.2% of cases!

But it’s not just the type of investment that influences the return! Above all, the costs incurred when investing reduce your profit! My sponsor Smartbroker is one of the most favourable providers for ETFs, shares, funds and precious metals! And with its huge selection, it offers everything an investor’s heart desires! You can trade with smartbroker from as little as 0 euros and pay no custody fees! You can register via my link: https://northern.finance/smartbroker-de

But back to the investment comparison: What about the risk of individual investments? Take a look at this chart of the S&P 500. Here you can see a comparison of the volatility of the different types of investment. This shows that the individual investment (blue line) is subject to significantly greater fluctuations than the distributed investment (black line). Especially in times of crisis, at the beginning of the 2000s or during the 2008 financial crisis, the difference is very clear!

And now imagine this: You invest a large sum shortly before the crisis and then see your assets literally melt away just a few weeks later. You need strong nerves for that! Even if you know in the back of your mind that a one-off investment pays off more in 74.2% of cases than a spread investment!

You can now say: ‘Then I’ll just invest a large sum during a crisis’. During the coronavirus crisis, for example, you can also see that things went steeply uphill again after the big slump. But you only see that in hindsight!

During the crisis, when headlines conjure up a major stock market crash, it is not so easy to assess the risk of a large investment. Even today you can see that the economy is developing more slowly than expected. But the stock market is still doing great. It’s difficult to weigh up the risks here!

To summarise: there is no such thing as a 100 percent correct strategy. With one-off investments, however, you have to be aware of the risk and, if things do go downhill, you need strong nerves above all!

One-off investment: How do I reduce my risk?

A one-off investment is generally more risky than distributed investments. However, there are still methods that can reduce the risk for you! For example, it is worth rebalancing your portfolio from time to time. This means realising gains and reallocating!

If you already have a broadly diversified portfolio, losses won’t hurt quite as much – so it always makes sense to diversify! And not just with shares! To reduce risks, you can also look at other assets such as P2P loans, bonds or property. This way you diversify broadly and are more secure!

‘And what about my monthly ETF savings plan?’ Does that make sense? Yes! A monthly ETF savings plan makes sense if you want to put something aside from your salary each month. Unfortunately, we don’t receive our lifelong salary in advance so that we can invest it earlier! I myself invest in an ETF savings plan every month and have done very well with it so far. ETF savings plans are and remain sensible!