How pound-cost averaging works
Investing money regularly, instead of as a one-off lump sum, can reduce the impact of a market downturn on your portfolio.
What you will learn
- Why pound-cost averaging benefits investors in volatile markets
- Why regular investments are safer than ‘timing the market’
- Why drip-feed investing creates good investment habits
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 solid strategy.
If you have £10,000, for instance, you might invest £1,000 every four weeks for 10 months instead of investing it all in one go.
Adding up the benefits
Stock markets are, by nature, unpredictable. Prices sometimes swing wildly from one week to the next.
Steady, regular investments can provide you some protection in case of sudden drops. Instead of the entire £10,000 dipping in value, only the portion already invested will be impacted.
This strategy also evens out the cost of buying an investment. For example, a monthly investment of £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 for less.
Another advantage is not having to ‘time the market’ by buying shares when prices are low, and selling them when they reach their peak. This can be very tricky – even experienced investors struggle to get it right.
Timing the market is very difficult – even famous 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 will benefit from investment growth.
But, 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’re regularly investing for your future, rather than putting it off.
Regular investing also helps you to avoid ‘recency bias’, which is what happens when you put too much emphasis on recent market events. You can find out more about the effects of recency bias in our guide here.
Risk notice
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.
