How to invest a lump sum

It’s one of the most commonly-asked questions investment. And while the question seems obvious, some of the answers are often not so straightforward. This guide highlights the key considerations you’ll face as you decide what to do with your money. If you can address these, you’ll be on your way to making the most of your windfall. 

Your goals: now and in future 

Once the windfall lands in your bank or savings account it can pose some rather daunting problems. Should it go into a cash savings account, where it can earn a good rate of interest? Or is there the possibility of doing something more with it – and generate higher returns over time? 

First, determine whether there are crucial needs for the money right now. These could include, for example, paying off expensive debt. 

Next, consider the uses that you might eventually be putting this money toward. Could it be to help a child’s education costs? Or to help them fund a house purchase? The important factor here is when the money might ultimately be needed. If the target use is five or more years into the future, you could consider riskier investment options that offer higher long-term growth. If you are likely to need the money in the nearer-term, say within three years, then cash accounts might be a better solution. 

Stock market investing: get time on your side 

Stock market investing is risky in the short term but pays off over longer periods. In 2022 Schroders undertook a major piece of research looking at almost 100 years of stock market returns and comparing this with the returns on cash over the same period. We also took into account inflation. 

We found that if you invested for very short periods you would have a relatively high chance of making a loss if you invested in stocks and shares. So for one month, the chance of a loss was 40%. For 12 month periods, the chance of making a loss dropped to 29%; for five years it fell to 23%; for ten years 14% and for 20 years the chance of making a loss after inflation – based on 96 years’ worth of returns data – was zero. 

In other words, history suggests that where you hold on to your investments for long enough, your chances of making a loss diminish significantly. By contrast holding on to cash over longer periods can be risky, because cash is less likely to beat inflation (see below). 

A note of caution: while the figures above are very encouraging about long-term returns, don’t forget that stocks and shares can go up and down along the way. There may well be periods, especially in the early years, where your investments are worth less than you originally put in. 

Investment returns upon returns: the magic of compounding 

If you’re investing for a child, young adult or your own long-term goals, time can work its magic. “Compounding” describes the phenomenon in long-term investing where returns are re-invested as you go, and so attract further returns. Say you invested £10,000 at 6% per year for 30 years and simply drew the annual return of £600. Your gains would be £18,000 (£600 X 30), meaning along with your original capital you would have a total of £28,000. 

Compounding your returns, however, would result in much greater growth of your lump sum over the same period. 

Lump-sum: save £10,000, assuming 6% annual returns* 

After…  

*Compounded monthly 

Cash and the poison of inflation 

In the period since the Covid pandemic inflation has become a problem in many countries, including the UK. For many years preceding the pandemic this was not case, and as a result both savers and shoppers had become used to prices staying at relatively stable levels – this was what economists call a low-inflation environment. 

Now however inflation is more of a consideration. While cash on deposit might earn attractive nominal rates, such as 5%, this still falls far behind the rise in prices, which in mid-2023 was between 8% and 9%. 

As explained above, investing in shares offers a better chance of beating inflation than saving in cash accounts – provided you hold those investments for long enough. 

The chart below crunches historic stock market returns from a very long time period (January 1926 to December 2022) in order to show the percentage of timeframes where shares and cash have beaten inflation. 

Lump it and leave it 

There’s a popular adage in the world of investing: “time in the market is better than timing the market”. 

Financial markets are subject to mood swings, and the value of your holdings can rise and fall in comparatively short periods. Schroders’ research shows that in around half of the past 50 years stock markets fell by at least 10%.* 

This means you need to be prepared to weather the shocks in the short term – “lump it and leave it” – and stick to your original plan of investing toward your long-term goal. By comparison “timing the market” describes the process of trying to guess when markets might fall or rise, and move your money accordingly. This is dangerous. Investors who try to do this typically withdraw their money after it falls in value, and thus miss out on periods when the market regains its confidence and recovers. 

Spread your risks and limit the drags on your returns 

There are many suitable funds which act as ready-made portfolios for long-term investors. These will typically take savers’ money and spread it across the shares of many companies operating across a range of sectors and regions, giving wide exposure to different economies and trends. Some funds also hold bonds – issued by companies, governments or both – alongside shares, as a way of further diversifying the source of potential returns. 

Investing carries costs, and you should be aware of these and their impact on total returns over time. It is also important to limit tax on your returns where possible, for example by holding the investments inside an Isa. 

There’s plenty of helpful information available. Read our related guides to Stocks and shares Isas and successful long-term saving, for starters. 

*Source: Refinitiv and Schroders, data to 31 December 2022 for MSCI World Index.