Pound cost averaging
‘Little and often can do you good’
Surprisingly, there can be a positive side to volatile or ’bear’ markets for you. The much-misunderstood concept of “pound cost averaging” comes into its own in such market conditions.
In volatile or falling markets, it is extremely difficult to predict the bottom of the market in order to invest at the cheapest point. As a result many investors miss the bottom and end up investing once the market has started rising. However, if you make regular investments into a pension plan (or indeed any other investment, such as an ISA), rather than investing a lump sum, the average price paid per investment unit can be lower than the straight average of the investment price over the same time period, especially when the investment started in a falling market.
This can lead to greater potential investment value over time – in fact, the greater the market volatility, the greater the potential benefits for regular savers.
How volatility can work for, not against, retirement planning
The chart below illustrates two different notional stock market price scenarios – a market that rises and then falls, and a market that falls before rising.
The table below compares the effect of a single investment of £6,000 against investing £500 per month in the scenarios shown in the table. In all three notional cases, the starting price is the same as the end price, and the total investment is £6,000 – but the investment value at the end of the period is highest where the market fell before rising again.
Note: For example purposes only.
In our illustration:
- Regular investments in a falling then rising market show a 20% gain
- Regular investments in a rising then falling market deliver a 12% loss
- A single investment where a lump sum is invested and the market returns to its starting position in either direction delivers no gain at all.
These are fictional scenarios – and our examples do not include the effect of charges, which could result in lower gains or greater losses – but they powerfully illustrate that significant benefits can be gained from investing into a falling market if you believe that the stock market will recover in due course and are prepared to continue investing throughout this period. Obviously, this does not always happen, e.g. the market may not continue a downward trend, or may experience a sustained downward trend, or you could start investing just as the market turns upwards.
Advantages
- Potential to benefit from volatile or falling markets
- No need to try to ‘time’ the market or ‘call the bottom’
- Less frustration from potentially investing a lump sum at the ‘wrong’ time and watching its value decline
- Encourages investment discipline and a long-term view
- Enables the focus to be where, not when, to invest.
Disadvantages
- Missing out on the ‘best of the growth’ in a rising market
- No guarantees that the return will be greater than a lump sum investment
- Requires discipline not to cancel or suspend regular direct debit payments if markets continue to head downwards
- Any costs involved in making the regular investments will reduce the benefits of pound cost averaging (depending on the size of the charge relative to the size of the investment, and the frequency of investing).
You can achieve pound cost averaging for a pension or ISA via your Barclays Stockbrokers account by setting up a regular direct debit into your account and then logging into your account and buying online on a regular, say monthly, basis.
 Pension contributions |
