Pound cost averaging and the win-win of regular investing.
Published: 3 August 2016
Pound cost averaging might be a simple concept, but it’s one of the most compelling arguments in favour of regular investing. It’s particularly useful when investing in uncertain or volatile markets, reducing your exposure to the risk of getting the timing wrong.
What exactly is pound cost averaging?
Pound cost averaging is what happens when your money buys investments regularly at different prices, meaning you buy more for the same money when prices are low, and so benefit more if they rise.
By saving into your portfolio each month this can smooth out the highs and lows in prices, over time. When share or fund prices go up - which they typically do over the long term - the value of your shares or fund units do likewise. When they go down, your monthly payments are buying more shares or units, and you then get an extra bump in returns if performance improves again.
How does it work?
Let’s start by looking at an example.
Say you invest £1,200 over a year - £100 a month for 12 months, compared to investing it all at once at the start of the year. We’ve added in some price variations too.
This highlights how regular investing can increase the number of shares you hold overall. So in this example, when prices rise you’ll get the benefit of that on 252 shares, compared to 240 if you’d just made a single lump sum investment.
It also shows how you can miss out on the full benefits of a rising market unless you invest extra amounts while the shares are increasing in value.
The discipline of regular investing
An additional benefit of regular investing is that you’re less likely to try timing the market. It’s well known that time-in-the-market is more important, but emotional biases mean that many investors still make the mistake of selling when markets fall, meaning losses in the process.
A monthly direct debit makes it far less likely that you’re going to sell low and lose out on any rebound. Instead you’re in the habit of investing and less vulnerable to the emotional decisions that can derail even the best laid investment plans.
Regular investing is also a more sensible way of dipping your toe in the water than investing hundreds or thousands of pounds at once. Investing modest sums each month may be a more realistic way of investing for most people than paying large one-off contributions.
Add in compounding, and it’s a win-win
Then there’s the effect of compounding. Regular investing can go hand in hand with reinvesting the returns on your investment, which over time will generate their own growth - hence the popular reference to the ‘power of compounding’. To find out more on this, read our article on Harnessing the Power of the Dividend.
Important informationThese articles are designed to help investors make their own investment decisions. They do not constitute a personal recommendation to invest. If you have any doubts as to their suitability you should seek expert advice. Please be aware that the value of investments can fall as well as rise so you could get back less than you invest.
Your existing pension may have valuable benefits which you might lose when you transfer.
Laws and tax rules may change in the future without notice. The information here is our understanding in July 2016.This information takes no account of your personal circumstances which may have an impact on tax treatment.
Past performance is not a guide to future performance.