September 24, 2022

In this series, we’ll cut through the jargon and explain a popular investment term or topic. Here it is a pound-averaging cost.

What is pound cost averaging?

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With this simple method of investing, you pour money into the stock markets every month or every quarter rather than trusting a lump sum from the start.

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If, for example, you have £3,000 to spare, you are investing £250 per month rather than betting the whole amount.

The goal is to limit the damage from declining stock markets by lowering the overall average value of your investments, since each regular investment buys more units during periods of market weakness and fewer units during periods of market growth.

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Risk sharing: You inject money into the stock markets every month or every quarter instead of entrusting a lump sum payment from the start.

Who should invest in this way?

Sterling cost averaging is the perfect way to limit the risk of investing in stocks as a beginner. It’s good to establish a routine – “reinforce good behavior” as some would say.

But it also suits seasoned investors who are wary of the direction of the stock markets, but don’t want to miss out on profit opportunities, and also want to be ready for growth.

They see dripping money into the markets as good discipline, recognizing that you may have to buy on the way down to benefit from a full recovery.

What is the main benefit of this?

This takes some of the emotion out of investing in stocks and stocks – you’re also more protected from volatility. You don’t have to guess if you’ve picked the best time to buy. Instead, commit to making regular contributions, whether prices rise or fall. You should sleep easier.

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Is there a downside?

Yes, if the stock markets rise during the period you are investing, it would be more profitable to invest the entire £3,000. But at least you got some benefit—and saved yourself some worry.

Where did the phrase come from?

Many of the benefits of this system were first popularized in the American book The Intelligent Investor, published in 1949, where it was called “dollar cost averaging” and described as a means of securing a “satisfactory overall price” for your assets.

The book was written by Benjamin Graham. He is best known today as the man Warren Buffett, who runs the powerful Berkshire Hathaway fund, considered his investment guru.

Buffett says his own philanthropy has been inspired by admiration for Graham’s generosity of ideas and more.

Does the averaging differ?

Yes. Under this system, you change the amount you invest each month or quarter, increasing your investment if prices go down. Some fans make it their goal to grow their portfolio by investing more money if they don’t reach their goal. There is more work and more risk.

How can I start?

Most fund management groups offer monthly savings plans. You can also open an account with providers like Nutmeg by choosing the level of risk you want to take and your long term goals.

Platforms (online investment supermarkets) such as AJ Bell offer monthly savings promotions and Isas (individual savings account) promotions. Isa’s annual allowance is £20,000.

Sterling cost averaging could be an incentive to make the most of this tax break.

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