Pound-cost averaging

Cultivating a habit of disciplined investing, smoothing out market fluctuations and reducing overall risk

There may come a time in your life when you are fortunate enough to come into a large sum of money. This could result from a matured savings or investment plan, the sale of a business or valuable assets like a house or an inheritance.

When this happens, if you intend to invest this money, you’re presented with a quandary: should you invest all the money at once or gradually introduce it into the market over time? When faced with this choice, many investors opt to distribute their investment over time. This means they don’t invest at a single price point, but rather average out their investment level in the market.

Smoothing out the market’s fluctuations
This strategy is often referred to as “pound-cost averaging”. This strategy can help smooth out market fluctuations and reduce overall risk.

Predicting the perfect time to enter or exit the market can be highly challenging, and investors often face the danger of investing at the peak of a market cycle or withdrawing at the lowest point. The comparison between pound-cost averaging and lump sum investing is crucial in investment decisions.

Navigating market volatility
Regularly investing can result in a lower average purchase price than a single lump-sum investment at the market’s peak. Consistent investments over time can help flatten the market’s highs and lows.

Pound-cost averaging involves consistently investing a set amount, irrespective of the market’s ebbs and flows. In contrast, lump sum investing requires deciding when to invest.

The principle behind pound cost averaging is simple. It can be done by gradually investing a large sum – for instance, investing £20,000 each month
for ten months from a £200,000 lump sum.

Pound-cost averaging can:

Provide a methodical, disciplined investment strategy
Alleviate the stress of lump sum investments made at inopportune times
Offer a more steady and predictable entry into the market
Assist in lessening the effects of declining asset prices

Adopting open-ended investment strategies
Alternatively, you could opt for an open-ended pound cost-averaging strategy by investing £2,000 monthly. This approach ensures that you’re investing regardless of the market’s state. Pound cost averaging can also aid in limiting losses while cultivating a habit of disciplined investing and providing purchases at lower prices during market downturns.

Enhancing savings with incremental investments
However, any costs associated with regular investments may decrease the benefits of pound cost averaging. These costs depend on the charge relative to the investment size and the frequency of investment.

As time progresses, you’ll likely be able to increase your monthly investment amount, thereby giving your savings a valuable boost. Regardless of the investment size, committing to regular savings over an extended period can accumulate into a significant sum.