Here is a quick guide to pound cost averaging:
What is pound cost averaging?
Pound cost averaging is system of investing where you invest at regular intervals rather than one lump sum.
The advantages of pound cost averaging
Mentally investing is not easy. When the markets go down or there is bad news the natural reaction is to sell. We are hardwired to avoid loss so many investors fall into the trap of selling low.
Investing regularly means you have a disciplined approach to investing. This reduces the chance of you overreacting so you do not sell at the lowest points.
It helps to reduce the volatility in your portfolio. By investing regularly, you don’t have to worry about the market highs and lows as the price of your investments will balance out overtime.
This also helps you to time the market as you will be buying at the lows, giving your investments a greater chance to grow. It reduces the risk of investing all your money at market highs.
You can invest in small amounts. You don’t need to save up a big amount to start investing. Some platforms let you regularly invest from as little as £1.
The disadvantages of pound cost averaging
Some platforms charge a reinvestment fee which increases your costs and eat into your profits.
You can miss out on potential gains. You may miss out on the start of a long up trend by only putting in a small amount at the beginning. Also, your money is not working for you if it is sitting uninvested.
How do you do it?
It is very simple to get started. Make sure you start saving. Then, open an investment account and set up direct debit. Most investment platforms give you an option to reinvest regularly.
Pound cost averaging summary
Is pound cost average right for you? That really depends on your investing behaviour and attitude to risk. If you are risk adverse or do not feel you have a disciplined approach to investing it may be right for you.
It takes away the stress of worrying if you are investing when the market is too high and makes sure you do invest when the market is low.
Investing at regular intervals is a good strategy for long term for those investing in ready-made portfolios or index funds. It is not as suitable to individual shares as there may be times when it is not advisable to continue investing in an individual company. There is not the same risk in a ready-made portfolio or index fund. They are invested in 100s of companies, so the impact of any individual company failure is minimal.
If you are new to investing or nervous about investing a lump sum in one go, pound cost averaging is a highly effective system.