Keep calm and carry on investing with pound-cost averaging
Pound-cost averaging is a simple strategy to overcome fear and make sure you capitalise on a crisis.
Most crises ultimately turn out to be outstanding times to invest. There are obvious exceptions to this rule: buying shares in St. Petersburg in 1917 or Shanghai in 1949 in the hope that the situation would improve did not work out. But assuming that the entire economic and political system in which you live is not going to be turned upside down – in which case the best investment may be some gold and a ticket to somewhere far afield – people usually look back in admiration at those who kept calm and bought at the bottom.
There are two barriers to being one of these investors. The first is identifying when you’ve hit the bottom. The second – which is often underestimated – is the sheer psychological difficulty of investing when all the news is bad, other investors are selling and everything is telling you to do so as well. There is no easy answer to either of these problems, but pound-cost averaging is one of the simplest strategies we can use.
Little and often
Pound-cost averaging – also known as drip- feeding – is less sophisticated than the name sounds. It simply means feeding a sum of money into the market at regular intervals rather than in one go. So if you have £1,200 to invest this year, you might invest £100 per month. If you have £12,000, you invest £1,000 per month.
The advantage of investing this way is that it reduces the risk (and pain) of buying just before the market drops. If you put all your money in UK shares this month and the FTSE 100 drops steadily over the next year to end up down 30%, your portfolio is also down 30%. If you invest equal amounts monthly, your portfolio may end the year down half that – making it easier to hold your nerve and wait for the recovery.
Obviously if markets rise rather than fall over the time you are averaging your investments, you will make smaller profits than you would if you bought at the start. And the outcome can never be as good as it would be if you somehow invested everything right at the bottom. But a disciplined approach to regular investing helps overcome the inertia and fear that might stop you investing at all until the best of the recovery is over. You also avoid expending effort on trying to identify exactly when a bear market is over, something that you are unlikely to get right: it is enough to believe that markets offer good long-term value.
Most brokers offer regular investing schemes, where you set up a fixed amount to be invested each month and pay a low dealing fee (eg, £1.50 per trade). Not only does this save on costs, but making your investments as automatic as possible means that you are more likely to keep buying when the panic is at its peak.