When Stock Markets crash, as they did at the end of March this year due to the economic effect of the Covid-19 pandemic, many investors are put off the idea of risking any of their capital in an investment. However, you will find that savvy investors are the ones investing their money whilst unit prices are low.
There is no easy way to time the market, nobody knows when we’re at the bottom of a decline, and similarly, no-one knows when stock values will recover and how quickly.
By investing a regular, monthly amount, you are automatically benefitting from purchasing more units when prices are low, and less units when prices are high. For example a £50 monthly investment will purchase 50 units when unit prices are £1, but when unit prices rise to £2 per unit, you will purchase 25 units.
‘Pound Cost Averaging’ refers to the idea of smoothing out market volatility through the purchase of greater or fewer units depending on the unit price.
Regular, or phased investing also removes the worry around investing a lump sum immediately before a market fall.
For example, if Mr H invested a lump sum of £10,000 on 1st March when unit prices were £2, he would purchase 5,000 units and the value of his investment would fluctuate in line with the unit prices over the coming year as shown in the table below. Whereas, if Miss R were to invest the same amount, but phased over a period of 10 months (£1,000 per month), she would purchase more units when prices are low, or less units when prices are high.
As the above example shows, Miss R could be £1,268.50 better off than Mr H after just one year of investment because she phased her £10,000 into the market over a period of 10 months. Miss R was able to purchase a greater number of units overall, because she could take advantage of when unit prices fell (her £1,000 monthly investment was purchasing more units).
Of course, there could be times when investing a lump sum proves to be more beneficial than phasing an investment - when unit prices continue to rise consistently, with no downward falls along the way. In this example, if there hadn’t been a dip in unit prices between March and November, and instead the unit prices had steadily risen over the same period of time, Mr H would have more units than Miss R because he bought them before the price increased.
Investment always carries a risk and the value of your investment will rise and fall, with the risk of losing some or all of your capital.
The principle of pound cost averaging applies to regular investment into a Stocks & Shares ISA, other Investment Account or a Pension. Please contact me for a review of your finances.
Charlotte Owen
There is no guarantee that pound cost averaging will result in better returns than lump sum investing.
The example returns do not take into account product or adviser charges.
The unit prices used in the example above are hypothetical prices for the purpose of illustration.
This represents my understanding of pound cost averaging and does not constitute advice,
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