What is pound cost averaging?
If you have a lump sum of money to invest, it can be hard to know where to start – and even harder to work up the courage to actually part with your cash.
When you’re deciding how to invest, you have two options:
- Invest it all at once and hope that the market performs consistently well so your investment increases month on month.
- Drip feed that lump sum into your investment pot with regular payments over the course of a few weeks, months or years.
The idea of pound cost averaging is to make regular contributions to your investments to try and smooth out the ups and downs of the market. There are no guarantees with this approach as the value of all investments can go down as well as up.
A simple example of pound cost averaging
The good bits
Smoothing out the ups and downs
The logic behind pound cost averaging is that some months, if the market is doing well, your shares will be worth more and so more expensive. But if the market isn’t doing so well, shares will be cheaper. So, if you buy a few shares every month, the idea is that the cost will average out over time.
Volatile times
Pound cost averaging could be favoured by investors when the market is volatile. If markets fall you would be buying shares at a cheaper price – so you’ll hopefully get a bigger return on these once the market picks up again.
An investor who invests a lump sum might miss out on buying cheaper shares if they invest their money before a market downturn. This could impact their potential return too. This means their potential return could be less too.
Less daunting
If you’re nervous about putting all your eggs in the same basket at once, pound cost averaging can be a useful way to overcome that emotional hurdle.
Good behaviour
Importantly, pound cost averaging can create a more disciplined investment approach. It can be good practice to invest little and often, for the long term. If you’re applying that logic to any lump sums of money you want to invest, it can only reinforce that approach.
The not-so good bits
The good times
The obvious question surrounding pound cost averaging is: what happens when the market goes up? The answer: you end up buying shares at increasing prices. In this case, investing a lump sum from the start would mean you bought all your shares at the lower price, which could potentially mean a higher return over the longer term.
Cash isn’t always king
It’s important to remember that any money you don’t invest will be kept as cash. And, if you keep your money in cash for a very long time, you may even lose money, thanks to inflation. So if you choose to pound cost average, it’s a good idea to set yourself a timeframe to invest in.
In it to win it
Ultimately, if you want to see a return on investment, over and above what the current bank or building society rates can offer you, investing can help you to do this. And pound cost averaging could be one way to feel comfortable doing that.
As with all investments, remember your money is at risk and you may get back less than invested. So take time to do your research and get some financial advice if you're unsure of what to do.
Put pound cost averaging into practice
Setting up a regular investment is a good way to automate pound cost averaging with your accounts. But remember, there’s no guarantee it will give you a better outcome than investing a lump sum.
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