In the light of recent market volatility, it’s perhaps natural to be looking for ways to smooth out your portfolio’s returns going forward.
In a fluctuating market, investing regularly – a strategy known as ‘pound-cost averaging’ – can help smooth out the effect of market changes on the value of your investment and is one way to achieve some peace of mind.
Increasing the long-term value
This simple, time-tested method for controlling risk over time enables you, as an investor, to take advantage of stock market corrections. By using pound-cost averaging, you could increase the long-term value of your investments. There are, however, no guarantees that the return will be greater than a lump sum investment and it requires discipline not to cancel or suspend regular Direct Debit payments if markets continue to head downwards.
Investing money in equal amounts
The basic idea behind pound-cost averaging is straightforward – the term simply refers to investing money in equal amounts at regular intervals. One way to do this is with a lump sum that you’d prefer to invest gradually – for example, by taking £50,000 and investing £5,000 each month for ten months.
Alternatively, you could pound-cost average on an open-ended basis by investing, say, £1,000 every month. This principle means that you invest no matter what the market is doing. Pound-cost averaging can help investors limit losses, while also instilling a sense of investment discipline and ensuring that you’re buying at ever-lower prices in down markets.
Taking advantage of market down days
Investment professionals often say that the secret of good portfolio management is a simple one: market timing. Namely, to buy more on the days when the market goes down and to sell on the days when the market rises.
As an individual investor, you may find it more difficult to make money through market timing. But you could take advantage of market down days if you save regularly, by using pound-cost averaging.
Committing to making regular contributions
Regular savings and investment schemes can be an effective way to benefit from pound-cost averaging and they instill a savings habit by committing you to make regular monthly contributions. They are especially useful for small investors who want to put away a little each month.
Investors with an established portfolio might also use this type of savings vehicle to build exposure a little at a time to higher-risk areas of a particular market.
Averaging out the price you pay for market volatility
The same strategy can be used by lump sum investors too. Most fund management companies will give you the option of drip-feeding your lump-sum investment into funds in regular amounts. By effectively ‘spreading’ your investment by making smaller contributions on a regular basis, you could help to average out the price you pay for market volatility.
Giving your savings a valuable boost
Any costs involved in making the regular investments will reduce the benefits of pound-cost averaging (depending on the size of the charge relative to the size of the investment and the frequency of investing). As the years go by, it is likely that you will be able to increase the amount you invest each month, which would give your savings a valuable boost. ν
Levels and bases of reliefs from taxation are subject to legislative change and their value depends on the individual circumstances of the investor. The value of your investments can go down as well as up and you may get back less than you invested.