Pound cost averaging

Stock markets can be highly volatile, rising one day only to fall the next. Therefore a good way to invest long term is to drip feed money into shares or units on a regular basis – to get the benefit of pound cost averaging – rather than committing a single larger lump sum.

Suppose you have £400 to invest over 4 months and this buys 100 units in a fund at £4 each when the FTSE 100 is at 6,000 points. Invest the lot straight away and you get 100 units. Alternatively you could drip feed in £100 per month.

Your first £100 buys 25 units (100/4). With the market at say 5,700 after a month, the second £100 buys 26 units at £3.80 each (5,700/6000 x £4). The next £100 buys 27 units with the market at say 5,500 points and then the FTSE recovers to 6000 and you buy a final 25 units.

Overall you have bought 103 units this way, now worth £112, which beats owning 100 units worth £400 via the lump sum approach.