Many concepts in investing sound far more complicated than they are. “Pound-cost averaging” – also known as “drip feeding” – is no exception. It simply means investing 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 a month; if you have £12,000, you invest £1,000 a month.
The advantage of investing like this is that it can reduce the risk – and pain – of buying just before the market drops. For example, if you put all your money in UK shares this month and the market drops steadily over the year to end up down 20%, your portfolio will also be down 20% (ignoring dividends).
But if you invest equal amounts monthly, you buy in at a lower price each time and so reduce your average cost. So your portfolio may end the year down by around 10% rather than 20%. In turn, that’s less painful, which may make it easier to hold your nerve and wait for the recovery. If markets rise rather than fall over the same period, you will of course make smaller profits than you would have, if you had invested a lump sum at the start.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Critics of pound-cost averaging point out that most major markets have risen substantially in the last few decades. As a result, pound-cost averaging has not delivered the best long-term returns. However, a useful lesson to learn about investing is that the best strategy is not the one that’s best in theory, but the one you can actually stick with in practice.
In an ideal world, we would calmly stick to our plans through thick and thin. But it’s easy to panic in a crash when you see your portfolio’s value falling. Following the pound-cost averaging route – rather than committing all of your money at once – may help you to stay invested during a crisis, rather than pulling your money out at exactly the wrong point.
A disciplined approach to investing small amounts can also help you to overcome the fear that might stop you entering the market at all until the best of the recovery is over.
For more on workable investment strategies, subscribe to MoneyWeek magazine.
-
8 of the best lakeside properties for saleThe best lakeside properties – from a house on the southeastern shore of Loch Lomond, to a 15th-century hall overlooking a lake in King’s Lynn, Norfolk
-
Gold’s allure and why you should never 'pay a premium for graded coins'It is easy to become distracted by the beauty of gold, but remember why you buy it, says Dominic Frisby
-
What is a dividend yield?Videos Learn what a dividend yield is and what it can tell investors about a company's plans to return profits to its investors.
-
Fiscal drag could cost millions of earners thousands – what is it, and how can I protect my money?Videos The government froze tax thresholds, which will drag employees into higher tax bands as wages rise with inflation. We explain what fiscal drag is, and how to avoid it.
-
What is a deficit?Videos When we talk about government spending and the public finances, we often hear the word ‘deficit’ being used. But what is a deficit, and why does it matter?
-
Too embarrassed to ask: what is moral hazard?Videos The term “moral hazard” comes from the insurance industry in the 18th century. But what does it mean today?
-
Too embarrassed to ask: what is contagion?Videos Most of us probably know what “contagion” is in a biological sense. But it also crops up in financial markets. Here's what it means.
-
Too embarrassed to ask: what is stagflation?Videos Traditionally, economists and central bankers worry about inflation or recession. But there is one thing worse than both: stagflation. Here's what it is
-
Too embarrassed to ask: what is the metaverse?Videos The term “metaverse” sounds like something out of a science fiction novel (and it is). But what does it actually mean?
-
Too embarrassed to ask: what is the gold standard?Videos These days, most currencies are "fiat" currencies backed by the economies of the countries that issue them. But in days gone by currencies were on the "gold standard". Here's what that means.
