Anyone looking to invest right now will be confronted with a degree of uncertainty. We’re slowly venturing out of what has been a period of serious upheaval, not just for global health but also for the markets. The situation, in the markets at least, has been relatively steady for a while now, giving many the confidence to start looking toward a ‘post-coronavirus’ economy.
For investors, the consensus seems to be that further extreme swings, the likes of which we saw in March, are unlikely. The second quarter of the year saw the best performance in the markets since 1987 as the losses of the first quarter were, in part, recovered. Going forward, we may see fewer dramatic movements either way. In situations like these, it’s often slow and steady that wins the race.
In the interest of careful, planned investing, we recently introduced an update to our service that allows investors to drip-feed funds into an account to bolster their long term growth. This allows for a technique called pound cost averaging, a common and effective long-term investment strategy.
What is pound cost averaging?
If you’re lucky enough to be presented with a lump sum to invest at any point in your life, deciding how to use it is significant. People will often say that the most sensible thing to do with a lump sum is to ‘invest it’, but there’s more than one way to do that. You can either invest it in one or more lump sums or drip-feed it into the market over an extended period of time.
We call the latter ‘pound cost averaging’. This is a technique where you make investments on a regular basis and therefore average the price you pay for the total investment over time. Most investment instruments – including ETFs – are available for purchase through regular savings plans (like ISA schemes), which allows investors to top up on a regular basis.Get started with regular top ups
Investing slower and smarter
Ultimately, this approach negates the difficulty and risk inherent in timing the market, because it’s not the goal. Where timing the market requires near-superhuman foresight, the goal here is to continue investing while avoiding market speculation and ironing out the fluctuations in an asset’s price over time.
No one wants to buy at the top of the market. Equally, no one wants to miss out on further bargains if the market drops even further than what you might perceive to be the bottom. So, rather than the entire investment portfolio taking on a loss or feeling the burn of a missed opportunity, pound cost averaging means only that month’s investment does, for example. The rest can then be regularly invested at the lower prices.
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A pound cost averaging strategy means that the most difficult decision you need to make is how much and how often you want to invest. Setting up a direct debit to take care of the transfer makes the process even easier. The flexibility that comes with ‘little and often’ payments means that, without committing a large chunk of cash at any one time, you can change the direction of your portfolio building without having a detrimental impact on the investments made so far.
Ideal for uncertain times
Despite relative stability, the future as we grapple with the effect of a global pandemic on the economy is uncertain. It is only natural, then, that sensible investors would want to mitigate the risk they take on when putting money away. We have written extensively about the ineffectiveness of holding cash in times like these, which means navigating the markets safely is the best option for most savers.
Human beings are naturally risk-averse, particularly when getting started with investing. Pound cost averaging means smoothing out the volatility and avoiding investing heavily at the peak of the market. When markets go up, what you already have invested will too; when they go down, your next regular investment buys more.
There are fears that a second wave of coronavirus cases could lead to further lockdown measures, as we are already seeing in localised regions across Europe and elsewhere. It’s likely that areas of the economy will have become more robust and prepared for what may come but, even so, investors may well want to avoid jumping in at the deep end in the market.Set up regular top ups
We’ve made pound cost averaging a part of our investment service. For anyone that favours a disciplined, regular investment pattern that fits with their income and long term plans, drip-feeding into an account can effectively take the emotion and speculation out of investing. We’ll still be actively managing investments and seeking out areas of potential opportunity, but you won’t be making any single defining decision about your investments.
Of course, as with all investing, pound cost averaging carries its own risks and there is no guarantee it’s the superior option. However, for anyone looking to navigate potentially choppy waters ahead through a careful, tried and tested investment strategy, it is certainly worth considering it as an option.