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.

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