How to harness the power of pound-cost averaging
- 3 min reading time
Investing money on a regular basis, instead of as a one-off lump sum, can help to reduce the impact of a market downturn on your portfolio.
What you will learn
For an investor seeking a smoother ride in volatile markets, pound-cost averaging – where money is drip-fed into the market over time – is a viable strategy.
If someone has £10,000, for instance, they might invest £1,000 every four weeks for 10 months instead of investing the whole amount in one go.
Adding up the benefits
Stock markets are, by nature, unpredictable and prices sometimes swing wildly from one week to the next.
This strategy also averages out the cost of buying an investment. So, a monthly investment of, say, £500 will buy fewer shares or fund units when markets rise and more shares or units when markets fall. In falling markets, that means you can buy more shares at a cheaper price.
Investing in regular instalments can provide some protection to the investor if the market suddenly drops. This is because, instead of the entire £10,000 also falling in value, only the portion already invested will reduce in value.
Another advantage is that you’re not trying to ‘time the market’ by buying shares when prices are low and selling them when they reach their peak – something that even the most experienced of investors struggle to get right.
Did you know?
Timing the market is incredibly difficult – even renowned investor Warren Buffet avoids this technique.
The price of pound-cost averaging
The downside to pound-cost averaging is that, in rising markets, you may be worse off than if you had invested a lump sum, as only the invested portion of your money is benefiting from investment growth.
However, because identifying favourable market conditions is so challenging, overall pound-cost averaging is viewed as a less risky approach.
It also builds good investing habits. Setting up a direct debit that feeds money into your portfolio every month means you are regularly investing for your future, rather than putting it off for another day.
Regular investing also helps you to avoid ‘recency bias’, a tendency to put too much emphasis on recent market events. You can find out more about the effects of recency bias in our guide here.
Any information provided should not be considered personal advice. Past performance is not a guide to future performance. You may not get back the full amount you invest. If you have any doubts about making your own investment decisions, seek financial advice.