Currently there is a great deal of market volatility. In these circumstances investors must focus on the fact that they are investing for the longer term.
Markets can fall quickly but can rise equally fast. A way of dealing with volatility is by utilising “Pound Cost Averaging.”
What is it?
Pound Cost Averaging is the concept of making regular contributions to your investments to smooth out market volatility.
By making regular contributions you naturally purchase fewer units of investments when prices are high and more units when prices are low.
Over the long-term, not only does this create a disciplined investment approach, but this strategy will help take advantage of volatile periods and potentially improve your returns.
Timing the market
I always get pleasure buying something today at a cheaper price than yesterday! Who doesn’t love a sale after all?
One of the greatest things about Pound Cost Averaging is that it removes the worry of making a lump sum investment right before a market decline.
Trying to time the market rarely pays off and often it’s more luck than skill, so even seasoned investors avoid falling into this trap. Using Pound Cost Averaging you can be safe in the knowledge that through volatile periods your money will be working to ensure you purchase units at a lower price with a long-term view.
Of course, there will be exceptions to this philosophy and there is no guarantee that Pound Cost Averaging will result in better outcomes than lump sum investing.
One of these exceptions is a consistently rising market where investing a lump sum from the outset will give you the lowest possible unit price and therefore generate the highest return.
However, the investment journey is rarely a smooth one and given no one knows for sure that markets will consistently rise over your investment journey, the Pound Cost Averaging method can be a useful tool to ensure you don’t buy at the wrong time and are able to take advantage of market volatility.
The example opposite shows the Pound Cost Average method for two different customers over a volatile period.
Customer A invests £1,000 a month over the year whereas Customer B invests £12,000 in January. Across the year, the market falls and rises with the unit price following the same trend.
By December, Customer A has been able to take advantage of falling prices and has purchased over 1,000 more units and paid a lower average price than Customer B. This leaves Customer A with almost £2,000 more over the 1-year time frame.
Market volatility is a fact of life. We have seen much of it recently. There is no perfect way of dealing with it so feeding in money over a period is a sensible approach.
If you would like more information, or would like to discuss your own position, then please do not hesitate to contact me or my colleagues, David Hughes and Denise Graham.
Tax advice is not regulated by the FCA and legislation is subject to change. Capital at risk. Rutherford Hughes Ltd. is authorised and regulated by the Financial Conduct Authority. Rutherford Hughes Ltd company registration no: 10431722. Country of registration: England. Office & Registered Office address: Collingwood Buildings, 38 Collingwood Street, Newcastle upon Tyne, NE1 1JF.