Can pound-cost averaging help you smooth out your investment decisions?

Whilst the long-term overall trend of the FTSE100 has been up, we have seen some quite dramatic short-term downturns since the financial and credit crisis of 2008.

In the last two years for example, the trend has been down, so just how does this impact on your overall investment strategy.

Two distinct types of investor are affected:

• The Lump Sum Investor – be that assets from a portfolio switch, an inheritance, child fund investment, or pension fund draw-down
• Regular Monthly Savers - most investors in Investment Trusts, Unit Trusts, and OEICS’ take advantage of the regular savings plans offered by those fund managers

In a stable or rising market the lump sum investor would always have the advantage, by locking in the investment at the lower entry level and then benefiting from the overall medium and long-term upward trend in the markets to take the profit from the increased asset price.

However, investment timing is everything and to get that consistently right in today’s highly volatile markets is extremely difficult.  To find the peaks and troughs of any investment asset price cycle is more an art than a science. Even very few experienced investors can consistently call the markets to this degree.

So what can they do?  Well, in a declining market, by spreading their lump sum investment over a period of months (or even years) they can achieve pound-cost averaging to smooth out their entry price for any asset and gain an advantage.

This of course does not guarantee a profit or protect your assets from a continually declining market.  The quality of the asset must always be your choice. What it does do though is reduce the loss that would have been incurred with the lump sum investment strategy.

Take a look at the following comparative example between a lump sum investment of £5,000 and the same amount invested over five months, which would benefit from pound-cost averaging:

A single lump sum investment of £5,000 in January:

This gives the investor an average purchase price of £2.50

The value of this investment after 5 months will be £3,300.00

An investment of £1,000 per month over 5 months:

This gives the investor an average purchase price of £2.04

The value of this investment after 5 months will be £4,158.79

By default the regular monthly saver will benefit from the pound-cost averaging illustrated above to smooth out their purchase price and thus benefit from the increased number of units the lower price affords them.

They gain by purchasing more units of the investment for the same overall outlay.

The lump sum investor may wish to consider adopting a similar purchasing strategy for all or part of their investment fund.

The vast amount of investment product available dictates that professional advice is taken to ensure that any investment and the timing of it accurately reflects the individual investors risk appetite.

It is important to take professional advice before making any decision relating to your personal finances.

NOTHING CONTAINED IN THE ARTICLE SHOULD BE CONSIDERED AS GIVING INDIVIDUAL FINANCIAL ADVICE. THE VALUE OF INVESTMENTS IS NOT GUARANTEED AND WILL FLUCTUATE. YOU MAY GET BACK LESS THAN YOU INVEST. PLEASE NOTE THAT THERE MAY BE VARIATIONS FOR THOSE LIVING IN SCOTLAND AND NORTHERN IRELAND.