Are you worried about how to time the investment of your savings. What if the market dropped sharply just after you did? Here is one idea about how to overcome the dilemma, together with two examples of potential outcomes.
Pound Cost Averaging – explained.
The idea behind pound-cost averaging is to provide some protection against the market dropping sharply shortly after your money is invested. It involves making a series of regular smaller investments over a period of time, rather than committing all of your capital to the market in one go. Instead of the entire investment suffering a loss if markets fall, only the invested portion does. Remaining instalments are then invested at lower prices which can boost the value later when markets recover.
When can you benefit?
Pound-cost averaging can work well in a falling market but not in all market conditions. The two examples below compare a single investment of £240,000 with regular instalments of £10,000 over 24 months.
Both scenarios assume a unit price of £1 at outset and a unit price of £1.50 at the end of 24 months. The single investment, represented by the grey line, will have purchased 240,000 units. This would equate to an end value of £360,000. The blue line shows how the value of the phased alternative would build, with the number of units purchased each month varying, depending on the price.
Example 1: Poor Early Market Performance
The first example shows how pound cost averaging works well if there were to be a period of poor performance after the investment commences. A fall in unit prices is programmed for the first 19 months of the investment period. The additional units purchased when prices are lower provide a boost to the overall value at the end of the period.
Example 2: Typical Rising Market
The strategy will, however, not deliver higher returns if the market were to rise steadily during the investment period, as shown below.
This example assumes the market price of the units purchased is higher than £1 for most of the months during which the regular investments are made. The total number of units accumulated using the phased approach is lower than the number purchased at outset if a single investment were made. This results in a lower valuation at the end of the period.
Herbert Scott cannot predict future market movements. Therefore, we are unable to recommend one approach over another. We also believe it is impossible to consistently get market timing right throughout your investment journey.
To discuss how to time the investment of your savings further, please contact us here.
Additional reading, published by Vanguard Asset Management Limited, on the subject of pound cost averaging can be found here.
This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article does not represent a recommendation of any particular security, strategy, or investment product. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.
The value of the investment is determined by the value of the units, the price of which can fall as well as rise. The overall value of the investment is therefore not guaranteed and you might get back less than you originally invested, especially in the early years.
Errors and omissions excepted.