Pound-cost averaging

Reducing exposure to falling markets

One of the biggest dilemmas investors face is market timing. Jumping in and out of markets on a regular basis not only requires constant monitoring of daily events but also requires the skill to act on such events. Even the best fund managers avoid trying to catch the top or bottom of a market.

It’s impossible to time markets perfectly, so it’s best not to attempt. The aim should be to improve your chances of entering the market at the right time. One way to achieve this is to spread or drip-feed a lump sum into the market as opposed to investing it all in one go. In fact, during volatile times, this strategy allows investors to benefit from what is known as ‘pound cost averaging’. So how does it work?

Regular intervals

The basic idea behind pound-cost averaging is straightforward: the term simply refers to investing money in equal amounts at regular intervals. One way to do this is with a lump sum that you’d prefer to invest gradually – for example, by taking £50,000 and investing £5,000 each month for 10 months.

Alternatively, you could pound-cost average on an open-ended basis by investing, say, £5,000 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.

Market timing

Investment professionals often say that the secret of good portfolio management is a simple one – market timing. Namely, to buy more on the days when the market goes down, and to sell on the days when the market rises.

As an individual investor, you may find it more difficult to make money through market timing. But you could take advantage of market down days if you save regularly, by taking advantage of pound-cost averaging.

Savings habit

Regular savings and investment schemes can be an effective way to benefit from pound-cost averaging, and they instil a savings habit by committing you to making regular monthly contributions. They are especially useful for small investors who want to put away a little each month.

Investors with an established portfolio might also use this type of savings scheme to build exposure a little at a time to higher-risk areas of a particular market.

The same strategy can be used by lump sum investors too. Most fund management companies will give you the option of drip-feeding your lump sum investment into funds in regular amounts. By effectively ‘spreading’ your investment by making smaller contributions on a regular basis, you could help to average out the price you pay for market volatility.

Valuable boost

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 saving over the long term can build to a sizeable sum. The key to success is giving your investment time to grow. Choose the amount you want to invest and set up automatic deposits. Once this is up and running, the chances are you won’t even notice it going out of your monthly budget.

Finding the best strategy

A number of factors should be considered before deciding on what kind of investment is most suitable for you. These include the purpose of the investment, the length of time your money can be tied up and your attitude towards risk. As all investments carry some degree of risk, we recommend that you seek professional financial advice to find the best strategy to achieve your long or short-term goals. To see how we could help you, please contact Admiral Wealth Management on 01472 357035 or email info@admiral-online.co.uk to discuss your requirements.

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