Handing the signed letter to European Council president Donald Tusk, ambassador to the EU Sir Tim Barrow officially triggered Article 50 on Wednesday, nine months after Britain voted to leave the European Union. Standing up to address the Commons, Prime Minister Theresa May hailed it an “historic moment from which there can be no turning back”.
UK investors are likely to feel nervous against this uncertain backdrop and may be wondering how to react – whether that’s by investing more or keeping money in cash. Although the UK economy has surprised most with its resilience in the nine months since the referendum, Brexit has sparked international uncertainty, both financially and politically.
Whilst the market backdrop is so uncertain and exposed to volatility, investors need to keep an eye on their long-term investment goal and should seek to increase the level of diversification in their portfolios. They should also seek to take a more risk adjusted approach to investing, such as pound cost averaging.
Perfect market timing is almost impossible
Correctly timing the market is one of the biggest challenges facing investors. To generate meaningful investment returns one would ideally invest when the market is at its lowest and sell when it is at its highest.
But timing trades isn’t easy; it requires constant monitoring of financial markets, the skill to respond to such events, and enough spare cash to cover the high cost of regular trading.
Even the best-known fund managers and investors believe it’s almost impossible to time markets perfectly. Warren Buffett once famously said: “We continue to make more money when snoring than when active.”
Investors are left asking themselves two questions: how do we avoid putting our long-term investment goal at risk, and what can we do to improve the chances of entering the markets at the right opportunity?
Pound cost averaging
One way to work around market timing is to take the little and often approach to investing, rather than investing a lump sum in one go. This strategy can be particularly beneficial during a time of turbulence and uncertainty. Pound cost averaging is a technique where an individual makes the choice to make investments on a regular basis and therefore averages the price they pay for the total investment over time.
Most investment instruments, such as single name equities, exchange-traded funds (ETFs) or open-ended mutual funds, are available for purchase through regular savings plans (such as ISA schemes) allowing investors to invest on a regular (such as monthly) basis.
The key benefit of this arrangement is that investors avoid market speculation whilst also ironing out the fluctuation of an asset’s price over time, therefore, taking away the worry of finding the right time to invest.
To illustrate this strategy, we have simulated the result of a monthly contribution investment approach in comparison with a lump sum approach when making the same investment.
Let us assume that an investor wanted to increase their exposure to the UK equity market by investing £13,000 in a UK stock ETF, such as iShares Core FTSE 199 UCITS, from July 2015. The investor can either invest the lump sum at the start of the period, or choose to make monthly contributions in equal tranches at the start of each month over the next year to average out the purchasing cost.
By making monthly contributions whilst investing in a volatile and falling market (such as Summer 2015) the investor bought more shares at a lower price (£6.25 per share and 2,081 shares in total). If the individual had invested the total amount at the start they would have paid £6.60 per share and 1,969 shares in total. This is equivalent to a discount of 5.4% in price terms and will ultimately boost performance of the portfolio when markets recover.
However, making regular investments over time in a rising market can also lead to a higher average cost of purchase compared to investing the lump sum at the start.
A smoother journey
In general, a pound cost averaging strategy provides more flexibility to investors as it avoids the need and opportunity cost of committing a large sum of cash at the start of the investment period. Investors can build a strong portfolio by investing little and often.
Establishing a disciplined and regular investment pattern is a great habit for UK savers at any time. In doing this, you take the emotion and speculation out of the investment process and returns will be smoother amid market volatility.
When it comes to investing, slow and steady wins the race.