31 May 2012

The Magic of Pound-Cost Averaging

Well that's a mouthful - and it sounds too technical to be bothered with, but sticking with me could be to your advantage. Pound-cost averaging is all about investing smaller amounts of money on a regular basis.

A volatile market (such as we have at the moment) can work to your advantage if you do that. The key point is that when markets are down, your regular sum of money will buy more shares or units, and that reduces the average cost of units in your holding.

Here's an example in a falling market, investing £100 a month:
  • Month 1 - If unit price is £25 you purchase 4 units
  • Month 2 - If unit price is £20 you purchase 5 units
  • Month 3 - If unit price is £10 you purchase 10 units
You now hold 19 units and have spent £300, so the average price you paid is £15.79.

Of course, you have to have an expectation that your investment will eventually rise in value again, but since you have a well-balanced, expertly selected portfolio (you have, haven't you?!) that's a perfectly reasonable expectation. And when the price does rise - say it goes back towards £25 - you have made a good return... much better than stopping investing until it has gone back up again!

A similar effect applies in a rising market, too.

It has been shown repeatedly that it's not possible to reliably judge the bottom of the market. So in the absence of that possibility, in a volatile market regular investing is the best approach.

30 May 2012

Now is the Time To ...

When people hear that share prices are falling, markets are uncertain, global economies are at risk, etc., the normal reaction is to want to leave it all behind and sell your investments.

But of course that's exactly the wrong thing to do. That's using short term information to make long term decisions. If your investments are in appropriate places then the ups and downs are expected and there's nothing you need to do.

In any case, by the time you've heard about a fall on the news, it has already affected any shares you hold - and its effect may not even be that significant if you have a sensibly diversified portfolio.

While timing the market has little place in financial planning, if you were going to do anything then now is the time to invest. When would you rather shop? When prices are high or during a sale?

One very effective way to invest is regularly - perhaps on a monthly basis. There are several areas where "magic" comes into financial planning - and "pound-cost averaging", which results from regular investing, is one of them. It especially works in volatile markets. I'll write another blog on that. (The amazing power of compound interest is another bit of magic.)

So now is not the time to sell up - now is the time to make sure you have a sensible financial plan, and then to invest if you can.

Blog Archive