What is pound-cost averaging? | moneyfacts.co.uk

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Michelle Monck

Michelle Monck

Consumer Finance Expert
Published: 17/08/2021

At a glance

  • Pound-cost averaging spreads out the purchasing of shares or other investments over time
  • Any lump sum used for pound cost averaging should be in an accessible and protected savings account
  • Pound-cost averaging can help to reduce the impact of buying at the top of the market

 

How does pound-cost averaging work?

Pound cost averaging is a strategy used by some investors to reduce their exposure during times when markets are dropping. If an investor has a cash lump sum, they can choose to invest all of this in the stock market. Any shares or investment fund units purchased will all be priced at the same rate. This means if the value of these rises or falls, all shares or units gain or lose in equal measure. The alternative is to use pound-cost averaging, the investor instead drip feeds the purchase of investments over time. In this example, the cost of the shares or units will vary based on the price paid at the time. If the value of these rises then the investor not only has to wait longer for the improved return, but the size of this return is also reduced as the investor is paying more for the same shares each time. However, pound cost averaging has benefits in times of volatility in the markets.

Moneyfacts tip

Moneyfacts tip Michelle Monck

Regular investments into a stocks and shares ISA or pension are like pound-cost averaging, in that the investor is buying into the market at different times and a result averaging out the costs. However, the investor is not holding back cash, they are using their maximum available monthly budget to fund these investments, for example a % of your monthly salary into a pension.

What is the benefit of pound-cost averaging?

Pound-cost averaging aims to provide some protection against the market reducing in value. It prevents the investor from using all their lump-sum to buy at the top of the market. Instead, the shares are bought as prices are falling, reducing the cost of the investment and therefore increasing the benefit of rising prices when markets improve. Overall, pound cost averaging can help smooth returns in investment markets that constantly move up and down. 

 

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What are disadvantages of pound-cost averaging?

Disadvantages of pound-cost averaging include reducing ad delaying the potential returns if the market is rising. Investors will also need their cash lump sum to be readily available and protected. This is likely to be in an easy access savings account, the interest paid will be lower than available on a fixed term savings accounts and could be lower than rate of inflation. Investors should also make sure they remain within the Financial Services Compensation Services compensation limit of £85,000. This could mean opening multiple accounts with different UK authorised banks. Find out more about depositor protection.

How does a savings platform work?

Those needing multiple accounts for their savings could consider a savings platform. These have one application process to access multiple banks and their accounts. Find out more about opening an account with a savings platform.

Disclaimer: This information is intended solely to provide guidance and is not financial advice. Moneyfacts will not be liable for any loss arising from your use or reliance on this information. If you are in any doubt, Moneyfacts recommends you obtain independent financial advice.

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At a glance

  • Pound-cost averaging spreads out the purchasing of shares or other investments over time
  • Any lump sum used for pound cost averaging should be in an accessible and protected savings account
  • Pound-cost averaging can help to reduce the impact of buying at the top of the market

 

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