Pound cost averaging
You’ll have heard that stock markets can be volatile and that the value of investments can go down. But there can be a positive side to these market conditions. This is where the concept of pound cost averaging comes in.
Pound cost averaging is about regular saving. When investing, it’s always best to buy at the cheapest point – when prices hit the bottom. Yet predicting that point is extremely difficult. As a result, many investors miss it and act when the market starts rising.
However, you can even out the ups and downs when you make regular payments into a pension plan, ISA or other investment, instead of paying in a one-off sum.
By investing once a year you take a big risk. Your investment may come in a period when market conditions aren’t favourable. By investing regularly – throughout the year, let’s say monthly – you spread the risk.
It works like this. The money in your fund is used to buy units. If the unit price at that point is lower than the average price over a period of time, this can result in greater potential value. Remember though that, as with all forms of investing, nothing is guaranteed. You could gain less or lose more than if you had invested in one lump sum.
How volatility can work for, not against, retirement planning
The chart below shows you a stock market that starts and finishes the year at the same value. But there are two scenarios – a market that rises and then falls, and a market that falls before rising.
At first glance, you may think that in each scenario your annual return is the same – it doesn’t matter whether you invest at the end of each month or at the start of the year. But the table below shows the different returns you achieve by making a single investment of £6,000 at the start of the year and by investing £500 per month.
Note: For example purposes only.
This example shows:
Our example is of course fictional. It doesn’t include the effect of charges, which could reduce gains or inflate losses. But it makes clear that significant benefits can be had from investing into a falling market – if it recovers in due course and you’re prepared to continue investing throughout this period. Obviously, this doesn’t happen all the time. Sometimes, there’s a sustained downward trend. Or you could start investing just as the market turns upwards – remember, you’ll never know whether the market is falling or rising until after the event..
Here are the advantages and disadvantages of regular – rather than one-off – investments.
You also need self-control not to cancel or suspend your regular payments when the market continues to head downwards. And it may cost you more to make regular rather than one-off investments, which potentially reduces the benefits of pound cost averaging. Remember too that all investments carry risk and you could lose some or, in extreme cases, even all of your money whether you invest regularly or not.
You can start pound cost averaging for a pension or ISA via your Barclays Stockbrokers account, using our Regular Investment Service. For this you have to set up direct debit payments into your account. Once these are set up, you can log into your account to buy online on a regular or monthly basis.