Pound Cost Averaging

Pound Cost Averaging is the strategy of making regular contributions to your investments in order to smooth out volatility.

Investors making regular contributions naturally purchase less units when the prices are higher and more units when the prices are lower. This strategy over the long term can help to balance out times of turbulence in the market. It can help to smooth out periods of volatility potentially improving your returns, as well as creating a disciplined investment approach.

Timing the markets

One of the greatest things about Pound Cost Averaging is that it removes the worry of making a lump sum investment right before a market decline.

Trying to time the market rarely pays off and often it’s more luck than skill- so even seasoned investors avoid falling into this trap. Using Pound Cost Averaging you can be safe in the knowledge that through volatile periods your money will be working to ensure you purchase units at a lower price with a long-term view.

Example 1

Example 1, shows the Pound Cost Averaging method for two different customers over a volatile period.

Customer A invests £1,000 a month over the year whereas customer B invests £12,000 in January. Across the year, the market falls and rises with the unit price following the same trend.

By December, Customer A has been able to take advantage of falling prices and has purchased over 1,000 more units and paid a lower average price than Customer B. This leaves Customer A with almost £2,000 more over the 1 year time-frame.

Trying to time the market rarely pays off and often it’s more luck than skill- so even seasoned investors avoid falling into this trap. Using Pound Cost Averaging you can be safe in the knowledge that through volatile periods your money will be working to ensure you purchase units at a lower price with a long-term view.

Key Points for Pound Cost Averaging

Helps create a disciplined investment approach
Removes the worry of making lump sum investment at the wrong time
Enables you to take advantage of market volatility
Is not always guaranteed to be the best strategy but is a low maintenance and lower stress approach

Example 2A - Investing through a financial crisis (2007 to 2009)

Example 2A, shows a real example of how using Pound Cost Averaging through the last financial crisis in 2007 to 2009 may have been beneficial.

The black line shows investment in the ABI Mixed Investment 20-60% shares with a single payment of £24,000 whereas the orange line shows regular £1,000 contributions over the same period.

You can see that the Pound Cost Averaging method here has resulted in a greater number of total units purchased, a lower average price paid and a higher final value.

Rising Markets

Of course, there will be exceptions to this philosophy and there is no guarantee that Pound Cost Averaging will result in better outcomes than lump-sum investing.

One of these exceptions is a consistently rising market where investing a lump sum from the outset will give you the lowest possible unit price and therefore generate the highest return.

However, the investment journey is rarely a smooth one and given no one knows for sure that markets will consistently rise over your investment journey, the Pound Cost Averaging method can be a useful tool to ensure you don’t buy at the wrong time and are able to take advantage of market volatility.

Example 2B - Investing in a rising market (Dec 2015 to Dec 2017)

Example 2B, shows a real example (using the same basis as in Example 2A) of how the Pound Cost Averaging method may result in poorer outcomes in a market that overall, has net positive returns.

What it really comes down to, however, is individual investor preference. Using either method (or even a mixture of both) as a well-structured, long-term investment strategy should help you on the way to building enough investments to support you through retirement.

Remember, investments can go down as well as up and you might not get back all the money you paid in.