Pound cost averaging explained…
This is the process of regular investing, typically on a monthly basis, to smooth out the peaks and troughs of the market within which you’re invested. Many investors start this way as a means of dipping their toe in the markets as the initial outlay is not significant.
The effect of pound cost averaging is you buying assets (typically units) at different prices on a regular basis, rather than buying at just one price – pound cost averaging is a less risky method of investing your savings.
Example: If you invested a £3,000 lump sum and bought units valued at £1 each, you would start with 3,000 units, ignoring any charges. Now, if you bought £50 worth of units per month over 60 months (amounting to £3,000 overall cost), you would buy 50 units in month 1. Let’s say the unit price dropped to 96p in month 2. Your £50 contribution would be able to buy just over 52 units. So: your full £3,000 investment is not affected by the drop in the value of units, only a small proportion of the money drops in value. After 60 months of regular investing and fluctuations in the unit price, let’s say the units are still valued at £1 at the end of the term. We are assuming investment into Accumulation units here as these do not pay an income to investors, and any dividends or interest payments are included in the unit price.
Had you invested with a lump sum, you would have the same £1,000 value at the end of the term. In the regular investment example you may end up with more units and therefore some return on your investment, despite the unit price being the same at the end of the term as when your investment commenced.
However, it is important to remember that you may not fully benefit from upswings in the market using pound cost averaging. A possible downside of regular contributions is that if the units continually grow, you will miss out on some of the growth as not all of your money has been invested for the entire term.
Given the above it is often worth considering lower cost solutions for regular contributions rather than paying for extra management of a fund, as the pound cost averaging factor can reduce the volatility and therefore we pay more attention to costs – often investors will build funds with a more passive approach using low cost trackers and such, until they have a sufficient level of funds to justify the additional costs of actively managing these.
If you are looking for regular savings tips to help increase your investment portfolios our trained financial planners may be able to advise you. Our financial services are catered to help individuals in Leeds, Wakefield and the surrounding Yorkshire area. For more information or a 30 minute consultation call our team on 0113 350 2080.