MTTM Podcast Episode 332 – Pound cost averaging weakness, Best student accounts & When to clear 0% interest debt

Episode 332 - On this week's podcast I look at whether investing a lump sum of money upfront outperforms dripping it in over time, with some surprising results. I discuss whether or not you should clear 0% interest debt ASAP. Finally, Bronte explains what you should look for in a student account and reveals the best accounts available right now.

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Abridged transcript - Episode 332

Below is an abridged transcript of episode 332, including timestamps.

Lump sum investing versus pound cost averaging - which is best?

Damien Fahy 3:31

We had a question from a listener and it said…

“Hi, I have an index fund (accumulator) that I invest in monthly over the long term that is performing at about 14% at the moment. I've just freed up some cash I want to add as a lump sum, but should I wait until it is performing slightly lower to reap maximum benefits from it?”

So this is an interesting question that I get asked quite often and in essence it is about market timing. Now, the first thing I'm going to say is that obviously, market timing is an impossible task to do with any kind of accuracy over the long term. It's a fool's errand to try and perfectly time the markets i.e. attempt to avoid any market slumps while gaining the maximum benefit from any rallies.

So back in 2016, I did a piece of research about market timing and how to invest a lump sum of cash, whether it's better to invest a lump sum in one go, or whether it is better to drip the money into the market over a period of time.

Now, the logical answer is that if you think the market is about to rally significantly, then you would be better off putting the money in as a lump sum straight away. Because if the market actually rallies all of your money will benefit from that rally.

Conversely, if markets fall 20% and you had put all your money in at the start, let's say that’s £10,000, then you're going to have lost £2,000 almost overnight.

If instead, you had dripped your money in over a period of time, you would have benefited from pound cost averaging when markets fell. Dripping in is when you decide to invest your money over a period of time in equal instalments. It could be, for example, that you decide to invest the £10,000 in £1,000 instalments over 10 months. The benefit of doing this when a market is falling is that every time you put money into the market it's slightly lower than the previous time you put money in and that means that your money is buying more shares than the previous month.

That means that in a falling market, by the end of the 10 month period you will have acquired more shares than if you'd invested a lump sum at the start. If/when the share prices rebound you will benefit to a greater extent than if you had invested all your money upfront. A good example of this is the five year period after the dotcom bubble burst (1999 to 2004). Had you dripped your money into the FTSE 100 in monthly instalments over the five year period you would have made an overall gain of 7% versus a -20% loss if you had invested all your money upfront in 1999.

When I carried out my original research I also looked at what happened if you dripped your money into the market over varying different timeframes. The research found that the longer the period of time over which you dripped your money into the market the less likely a drip-feed method of investing would outperform lump sum investing.

Theoretically, that makes sense, because the longer you take to drip feed your money into the market the less of your money is in the market at any given period of time, because it’s still sitting in cash, and so is not benefiting from compounding.

But what happens if you look at different markets and not just UK equity markets? What about if you invest in a mixture of enquiries and bonds and not just in equities?

In 2012 Vanguard carried out a piece of research that looked at the performance of dripping money into a market versus investing a lump sum upfront over various different timeframes, particularly 10-year rolling periods, going back as far as 1926. Vanguard also looked at how each approach fared in the UK, the US and Australia, Vanguard also considered the impact if you invested in bonds and equities, for example, a 60% equity and 40% bond mix. You can find a link to the full research paper in the resources section below.

But to summarise, Vanguard found that across all markets and timeframes on average the lump sum upfront method outperformed, over a 10 year period, the drip-feeding strategy 67% of the time. That is a significant difference.

Vanguard also found that over a 10 year period, on average, the performance boost was 2.2% in the UK and the US markets.

Should I pay off my 0% interest credit card debt or save instead?

Andy Leeks 13:04

Okay, and so the next piece then, was really inspired by a question that was asked through our Instagram account, and I'll read out the question:

Hii guys, I recently discovered your podcast, I'm already a fan. I wondered if you could provide input or maybe cover in the podcast how to address credit card debt, when it's 0% interest? Would it still be considered a bad debt? Is it worth paying straight away? Or is it a smart move to pay within the 0% interest term and save money elsewhere?

Damien Fahy 13:46

So the good debt bad debt equation isn't to do with the interest rate you're getting charged. The concept of good debt and bad debt is based upon what the debt was used for? For more information on good debt and bad debt listen to podcast episode 297, listed in the resource section at the bottom of the page.

The general rule of thumb with debt is that if you have savings, then you should pay back the debt with the savings because it doesn't make sense to try and save when you're paying a really high interest rate on debt, because the average APR on a credit card in the UK is about 17-18%. As you're getting next to no interest on savings accounts then if you keep a credit card debt and put any spare money into a saving account you are effectively paying to save.

With a 0% interest rate debt, it’s different because you're not technically getting charged on an ongoing basis for that debt. So should you pay it back or should you save and invest your spare money instead?

The first thing I would say is that you need to make sure you've got a plan in place to repay the debt before the 0% interest-free period expires if you can. That’s because if you've got a 0% interest debt and you don’t clear it during the 0% interest-free period then you will inevitably have to apply for another 0% credit card deal. Of course, there’s no guarantee that you will be accepted and of course, you will be required to have another credit check.

Also, if you eventually had to move the debt onto a new 0% interest-free credit card then there is usually a 2-3% upfront charge for doing so. That can get expensive.

The other thing I'm assuming when answering this is that you don't have any other higher interest-bearing debt. Because if you do, then 0% credit cards are a good tool when employing the snowball method of clearing your debt. This is where you pay the minimum on your outstanding debts, and then you direct any additional money you get to the highest interest-bearing debt. And then when you've paid that one off, you take the spare money you have each month (including what you had been paying each month towards the debt you’ve just paid off) and apply it to the next highest interest rate bearing debt. And you keep doing that until you get down to the 0% interest debt and you'll then be able to clear all your debt. You can find out more information in the article “The 5 simple steps to clear credit card debt” listed in the resources section at the bottom of this page.

But assuming that you haven't got any other debt, and you've got spare money then theoretically, you could be better off applying your money to a savings account, where you can get an interest rate of around 1% than clearing a 0% interest rate debt (which you should have a plan in place to clear before the interest-free period ends). Or rather than save the money you could invest it if you don't need access to the money for at least five years.

The other tip is to make sure you've got an emergency fund saved up because you need to have one to help break that cycle of debt. Listen to podcast episode 315 (see the resources section below) where I explain this in more detail.

But there is one occasion where clearing a debt and even 0% debt more quickly can be a good idea and that is when it constitutes a high proportion of your available credit limit. Let's say you had a credit card that you'd managed to get onto a 0% deal, but it was a really sizable debt and you had pretty much maxed out all of your available credit, then by clearing down that debt and reducing your percentage credit utilization you can actually improve your credit score with the various credit rating agencies.

The exact figure to aim for varies but if you have under 15%-20% credit utilisation a future lender will deem you a responsible borrower.

Finally, the other thing I want to mention is the positive emotional release that clearing debt can give. For some people, the feeling of getting rid of their debt and then moving into a life where they're not having to rely on credit cards can be very liberating. Once they're in that life where they're not feeling like they owe anybody any money, particularly bad debt, it can positively influence their behaviour going forward and make them less likely to start accruing debt again.

Best student bank accounts

Andy Leeks 20:06
Okay, so moving on to the final piece of the podcast, then we're going to welcome back a podcast favourite. Bronte, welcome back to the show. We're going to be talking about student accounts.

Bronte Carvalho 20:21

Thank you for having me back. Yeah. So we're going to be talking about student bank accounts today explaining what they are, what to look for in the best student accounts. And then we're also going to walk through some of the best ones on offer so far this year.

For the full breakdown of what to look for in a student account and which are the best student accounts read the article in the resources section below.

Resources:

• The best student bank accounts in 2021
• Vanguard research article: Pound cost averaging
• MTTM Podcast Episode 297 – Good debt vs bad debt, Winter portfolio update and energy bill help
• The 5 simple steps to clear credit card debt
• MTTM Podcast Episode 315 - SPACs explained, breaking golden rules & ditching the TV licence