Pound-cost averaging

Many of the people who use our service have come into a lump sum, be that be a bonus, an inheritance or other windfall, and are wondering how best to invest that money to maximise its growth. Their first questions are typically what to invest in and whether they should invest in one fell swoop or in tranches.

On the latter, one strategy investors might like to consider is pound-cost averaging, where you drip feed money into the markets in instalments over time, say every month. The idea is that you avoid buying at the top of the market and are protected to a degree from market falls just as you have put your money in because, should the market should take a sudden, short-term plunge, you would only suffer the loss on the latest portion of the investment, rather than the whole amount.

Pound-cost averaging appeals to those who appreciate that it is incredibly difficult – and nerve-wracking – to try to time the market perfectly. Drip-feeding your money in is also a solid approach for those who want to get into the habit of regular investing to build up a pension pot or other nest egg. This kind of strategy has even greater appeal at times when markets are showing themselves to be volatile and prone to unpredictable shocks. We have seen plenty of that recently with the coronavirus pandemic and geopolitical strife.

The downside of pound-cost averaging is however that markets rise more often than not, which is why historically equities have beaten most other assets hands down. Buying when prices are ticking up pretty consistently means you could end up paying significantly more to build up a position than you would if, for instance, you had spotted an under-priced security and snapped it up before the market at large saw its true value.

Another important consideration is that pound-cost averaging will probably mean a significant proportion of your wealth languishing in cash. This is bad enough when interest rates are poor, which they have been for many years; it is even worse when inflation is eating the real value of your money away. The growth of your wealth has to be at least keeping pace with inflation or you are in effect growing poorer over time.

All that being said, we do live in incredibly uncertain times and it might be the case that your best strategy could include pound-cost averaging to at least some degree. Arriving at the best investment plan for you requires careful consideration of your objectives, current wealth position, risk-profile and time horizon – and that strategy will also need to be adjusted over time as your situation, and that of the world, changes.

It is not enough to simply decide to invest. How you invest determines your eventual wealth position to a huge degree, so it is always a good idea to take professional advice before taking the plunge – and to review your strategy regularly.