Pound cost averaging: Smoothing out the ups and downs of the market
Pound cost averaging is a technique that reduces exposure to falling markets from investing a lump sum. Investing at regular intervals can be a good idea to help smooth out the ups and downs of the market. Timing the exact moment to enter or leave the market can be extremely difficult and investors inherently run the risk of investing at the top of a market cycle, or exiting at the bottom.
Pound cost averaging versus lump-sum investing is one of the most important concepts in investing. Buying at regular intervals means that the average price you pay can be lower than if you’d made one lump sum investment at the peak of the market. In other words, over time, regular investments can help smooth out the peaks and troughs.
Expecting markets to remain volatile
Pound cost averaging is the practice of investing a fixed amount at regular intervals, regardless of the ups and downs of the markets. But with lump-sum investing you need to decide when you’re going to invest.
Maybe, because the economy looks problematic right now with the coronavirus (COVID-19) pandemic outbreak and stock prices look like they could fall lower, you want to wait until things have settled down. Maybe you are expecting markets to remain volatile and you’d like to wait until this period is over.
Instilling a sense of investment discipline
The basic idea behind pound cost averaging is straightforward. One way to do this is with a lump sum that you’d prefer to invest gradually – for example, by taking £200,000 and investing £20,000 each month for 10 months.
Alternatively, you could pound cost average on an open-ended basis by investing, say, £2,000 every month. This principle means that you invest no matter what the market is doing. Pound cost averaging can also help investors limit losses, while also instilling a sense of investment discipline and ensuring that you’re buying at ever-lower prices in down markets.
Give savings a valuable boost each month
Any costs involved in making the regular investments will reduce the benefits of pound cost averaging (depending on the size of the charge relative to the size of the investment, and the frequency of investing).
As the years go by, it is likely that you will be able to increase the amount you invest each month, which would give your savings a valuable boost. No matter how small the investment, committing to regular savings over the long term can build to a sizeable sum. Please speak with your adviser if you have any questions or concerns.