Is pound-cost averaging really worth it?
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If I have £10,200 ready to invest in my shares ISA in 2011/12, should I invest all of it in April or is it really a better idea to make twelve £850 investments instead?
Benjamin Graham recommended pound-cost averaging -- making regular investments. But if I pick some diversified assets in April then should I invest all of it as early as possible? After all, there's next to no interest being paid by leaving the money in the bank until it's invested.
NeilBenson
1 year ago
Expert Financial Adviser Answer
Duncan Hannay Robertson
answered 1 year ago
The advice of pound-cost averaging is based on the long-term, not for short term one-off investments. It is also more about regular saving. For example, if you saved £10,200 over the next 20 years (assuming the ISA allowance is constant), the result is sometimes you will buy shares at a low cost and sometimes high. Ideally, we would all want the stock market to be low when we are buying and high when we need the money, for example at retirement. In the long run, regular savings is probaly going to give you better returns and a better nights sleep rather than the risk of timing the market. Its time in the market, not timing the market.
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Expert Financial Adviser Answer
James Brooke
answered 1 year ago
This is an excellent question and one that has no definitive answer, since it depends entirely on what happens to the price of the assets you are buying over the time during which you are buying them.
What do you expect to happen, over the next year, to the price of the assets that you propose to buy?
If the price constantly rises then pound cost averaging will have worked against you. You would have been better using all your money to buy the assets at the first possible date.
Conversely, if the price constantly falls then pound cost averaging will have worked in your favour. However, you would have been better to wait until the last possible date to buy the assets.
If the price fluctuates then it will depend on how it fluctuates.
The problem is that there is no tried and tested, proven, system of predicting what will happen to asset prices over a given short term period of time.
So, since investors do not know in advance what will happen to the asset price on a short term basis, pound cost averaging effectively allows investors to mitigate the risk of trying to time the market, and getting it wrong, by investing on a regular basis.
Pound cost averaging also helps to impose the discipline of investing on a regular basis and thereby helps to remove the regret of not being in the market when it rises or putting all ones money into the market just before it falls.
In short, pound cost averaging may not make you better off than you would have been if you had put all your money into the market at one point in time, but it will help to smooth out the ride.
Emotions matter when investing and one of the key underlying, and often un-stated, points about pound cost averaging is that using it tends to keep you in the market even if there is a large market correction or crash. This is because you know you are buying more units at the new lower price and this brings the average price at which you have bought units down, so there is no point in selling the units you already hold. Thus, pound cost averaging tends to stop investors trying to time the market.
It is important to remember that costs matter. If the cost of dealing, brokerage, and other charges and commissions is greater for you if you use pound cost averaging then this could have a significant impact. You will need to calculate the cost difference, if any, between investing as a lump sum and investing using pound cost averaging.
Lastly, some investments have minimum investment amounts that are too high to allow you to use pound cost averaging, so this may be an issue you need to consider too.
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What do you expect to happen, over the next year, to the price of the assets that you propose to buy?
If the price constantly rises then pound cost averaging will have worked against you. You would have been better using all your money to buy the assets at the first possible date.
Conversely, if the price constantly falls then pound cost averaging will have worked in your favour. However, you would have been better to wait until the last possible date to buy the assets.
If the price fluctuates then it will depend on how it fluctuates.
The problem is that there is no tried and tested, proven, system of predicting what will happen to asset prices over a given short term period of time.
So, since investors do not know in advance what will happen to the asset price on a short term basis, pound cost averaging effectively allows investors to mitigate the risk of trying to time the market, and getting it wrong, by investing on a regular basis.
Pound cost averaging also helps to impose the discipline of investing on a regular basis and thereby helps to remove the regret of not being in the market when it rises or putting all ones money into the market just before it falls.
In short, pound cost averaging may not make you better off than you would have been if you had put all your money into the market at one point in time, but it will help to smooth out the ride.
Emotions matter when investing and one of the key underlying, and often un-stated, points about pound cost averaging is that using it tends to keep you in the market even if there is a large market correction or crash. This is because you know you are buying more units at the new lower price and this brings the average price at which you have bought units down, so there is no point in selling the units you already hold. Thus, pound cost averaging tends to stop investors trying to time the market.
It is important to remember that costs matter. If the cost of dealing, brokerage, and other charges and commissions is greater for you if you use pound cost averaging then this could have a significant impact. You will need to calculate the cost difference, if any, between investing as a lump sum and investing using pound cost averaging.
Lastly, some investments have minimum investment amounts that are too high to allow you to use pound cost averaging, so this may be an issue you need to consider too.
Expert Financial Adviser Answer
Dr David Carter FPFS
answered 1 year ago
I am not convinced that pound cost averaging should have too much attention paid to it. It is a minor benefit to regular savers, but not (in my view) a reason to drip-feed a lump sum.
A parallel question is whether it is better to save up your cash and subsequently to invest it all in one go, or whether a regular investment programme is preferable. Here, pound cost averaging would lead you towards making a regular monthly investment, giving each available sum the maximum time in the market, and helping to reduce overall risk.
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A parallel question is whether it is better to save up your cash and subsequently to invest it all in one go, or whether a regular investment programme is preferable. Here, pound cost averaging would lead you towards making a regular monthly investment, giving each available sum the maximum time in the market, and helping to reduce overall risk.
Expert Financial Adviser Answer
Darren Smith
answered 1 year ago
I agree with David in that drip-feeding a lump sum is foolish and the only time i would entertain such an approach is if you are straddling two tax years when you invest and a short delay works in your favour to maximise your ISA either side of the tax year.
the key with a diversified portfolio is NOT "timing the market" rather it is "time in the market" you can only make these judgements retrospectively and you need to keep your long term goal in mind.
how can it make sense on a (for example) ten year investment to try and manipulate the market by dripfeeding the first year unnecessarily.
for anyone that can do that accurately, would be running their own funds, even the most expert of fund managers will not achieve "perfect" market timing.
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the key with a diversified portfolio is NOT "timing the market" rather it is "time in the market" you can only make these judgements retrospectively and you need to keep your long term goal in mind.
how can it make sense on a (for example) ten year investment to try and manipulate the market by dripfeeding the first year unnecessarily.
for anyone that can do that accurately, would be running their own funds, even the most expert of fund managers will not achieve "perfect" market timing.
BrianButcher
answered 1 year ago
Good question. The real answer to this can only be answered if we can predict the future of the markets - which we can't. The main benefit of pound cost averaging is that it reduces the risk of investment in the short term. Should markets have a good year then you will probably have been better to put all the money in at once. Should they fall then you will benefit by buying more units with your £850 when the prices are cheaper. Most investment houses have a positive outlook for equities over the next 12 months and are pretty neutral on property and fixed interest so I also suppose it depends on what asset classes you are going to buy with your cash. Hope this helps but, as stated at the beginning, we can't say which is best - we can only explain the concept of how pound cost averaging works in differing market conditions?
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Expert Financial Adviser Answer
James Brooke
answered 1 year ago
Neil, you will see from the answers that, whilst there is a certain amount of agreement on Pound Cost Averaging, there are several areas of debate.
David is right to suggest that it is better to invest your cash as and when you have it rather than to save up your cash to invest it all in one go later. It is time in the market that matters, as you are getting each amount of money into the market to work for you as soon as possible.
However, if you already have the lump sum it really depends on your tolerance of volatility and your ability to cope with regret.
David and Darren suggest that you invest it all in one go now, but it could be argued that, by investing all in one go now, you are timing the market as you are effectively saying that you believe the market is as cheap now as it is ever going to be.
How would you feel it the markets dropped 25% in the 12 months following your putting in the lum sum? Not at all happy I would suggest.
As you can see from this, it could well make sense on a (for example) ten year investment to drip-feed the money into the market in equal amounts over the first year.
Conversely, if you drip feeding the lump sum into the market in equal monthly amounts over the year you would feel much happier if the market dropped by 25% over the year, but how would you feel if it rose by 25%? Not very happy, perhaps, as you did not have all of the money getting the full benefit of the market rise.
We all agree that it is not possible to time the markets and for this reason there is, sadly, no right or wrong answer to your question. It depends on your personal attitude and how you would feel in different circumstances.
This is why I said that emotions matter and why we advise all investors to have a written investment philosophy and investment policy statement. That way they know what they are going to do in different circumstances, no matter what their emotions may be telling them to do at the time.
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David is right to suggest that it is better to invest your cash as and when you have it rather than to save up your cash to invest it all in one go later. It is time in the market that matters, as you are getting each amount of money into the market to work for you as soon as possible.
However, if you already have the lump sum it really depends on your tolerance of volatility and your ability to cope with regret.
David and Darren suggest that you invest it all in one go now, but it could be argued that, by investing all in one go now, you are timing the market as you are effectively saying that you believe the market is as cheap now as it is ever going to be.
How would you feel it the markets dropped 25% in the 12 months following your putting in the lum sum? Not at all happy I would suggest.
As you can see from this, it could well make sense on a (for example) ten year investment to drip-feed the money into the market in equal amounts over the first year.
Conversely, if you drip feeding the lump sum into the market in equal monthly amounts over the year you would feel much happier if the market dropped by 25% over the year, but how would you feel if it rose by 25%? Not very happy, perhaps, as you did not have all of the money getting the full benefit of the market rise.
We all agree that it is not possible to time the markets and for this reason there is, sadly, no right or wrong answer to your question. It depends on your personal attitude and how you would feel in different circumstances.
This is why I said that emotions matter and why we advise all investors to have a written investment philosophy and investment policy statement. That way they know what they are going to do in different circumstances, no matter what their emotions may be telling them to do at the time.