What Is Pound Cost Averaging?
If you're investing in the stock market and want to keep your portfolio steady, then pound cost averaging is for you. Simply put, pound-cost averaging is the practice of putting money into your investments on a regular basis, instead of one lump sum at a certain point of time.
If you're investing in the stock market and want to keep your portfolio steady, then pound cost averaging is for you.
Simply put, pound-cost averaging is the practice of putting money into your investments on a regular basis, instead of one lump sum at a certain point of time. It can teach you a non-emotional approach to investing because you'll be investing no matter what state the market is in.
Why Is Pound Cost Averaging Important?
The market is unpredictable. Sometimes it goes up, sometimes it goes down. When you're a regular investor, it can be hard to know when to invest your money—you might feel like you're missing out on the action if you don't jump in right when the market takes a dive, or you might feel like you're getting left behind if you don't get invested in time for a big rise.
There are no easy answers here. So we need some kind of system to help us make those decisions—and pound cost averaging is one way to do it.
You probably have heard the term "buy low, sell high" in relation to investing. The idea is that you should invest when the stock market is down, and then when it goes up, you can make money selling shares at a higher price than what you paid for them.
Instead of using your gut instinct to know when to buy low and sell high (which can be hard!), pound cost averaging lets you automatically invest small amounts regularly without having to guess whether or not it will be a good time.
Why Would PCA Outperform Investing in One Lump Sum?
The stock market tends to go up over a long period of time historically. If you look at the 10 year graph below, you will find that it looks more like a straight line going up.
When it comes to stocks, the longer the time interval, the “straighter” the line. However, if you look closer at this “straight” line you will find it is full of bumps and zig zags, because of the inherit volatility in equities. So while the general direction is up, it is really a series of ups and downs.
What Are the Benefits of PCA?
- If you invest too early, before a crash, you could lose out on the full value of the market's growth. On the other hand, if you invest too late, after a crash, then you might miss out on some of the best opportunities for growth. PCA lets you avoid timing the market altogether—by investing regularly over time, you are less likely to miss out on any single opportunity or get caught in an inevitable crash.
- When averaging, you are automatically buying shares regardless of the price. When the price goes up, you’ll buy less shares, and when the price declines you’ll buy more shares. This is what helps brings down your average cost of investing over the long term.
- Think of investing like a diet: you can't expect to lose weight in one day. You need to commit to healthy habits and stick with them, even when they're not easy. Pound cost averaging helps you get into the habit of regular investing, which is key to achieving your long term financial goals.
How do you Pound Cost Average?
Pound cost averaging might sound complicated, but in practice it's actually really easy.
I use Hargreaves Lansdown, which allows me to set up a recurring deposit from my bank account into the investment account, as well as an automatic trade every time money is deposited. This is actually one of the main reasons I use Hargreaves Lansdown, as it means I don't have to do anything on a regular basis.
If your investment account doesn't have this feature, then you'll need to set a reminder in your calendar to transfer money in and purchase your chosen investments manually each month/week.
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The Bottom Line
If you are new to investing, or if you want to put your money into the market but aren’t sure when to buy or sell, pound cost averaging is a great tool. You can use it while learning more about investing and working with a financial professional who can help guide you through the process of creating a reliable plan for long-term success.
The key thing to remember is that pound cost averaging is not intended as an investment strategy in itself; instead it provides an opportunity to invest at regular intervals with discipline and consistency.