FOOL'S EYE VIEW
The Beauty Of Pound-Cost Averaging

By Stuart Watson (TMFTiger)
August 27, 2002

The vast majority of people who invest, whether it's for their retirement or some other purpose, are better off doing so via investment funds. Buying a portfolio of individual shares is a difficult and time-consuming business and not something to be taken lightly.

The best way to invest in a fund is usually to invest small amounts on a regular basis rather than one great big whopping lump sum. So rather then leaving your ISA investment until 11:59pm on April 5, as so many of us seem to do, it's better to drip feed the cash in each and every month. Most investment funds, whether they are unit trusts, OEICs or investment trusts, have savings schemes that make it cost effective to invest in this fashion.

A regular investment takes up far less time too. Trying to time the market, jumping in and out on a regular basis, means keeping a constant eye on events -- not to mention the fact we'll probably get our timing wrong more often than not anyway. A regular monthly sum also instils a certain discipline into your investing habits - and most of us could do with a bit of that.

Benefit from a falling market

Most of all, the volatility of the stock market allows we to benefit from what is known as 'pound cost averaging'. The table below demonstrates how it works. Say we invest £100 each month in a fund. Its units cost £4 each when the FTSE 100 is at 4000 and the price varies in line with movements in that index.

        Value of the FTSE      Units Bought
Jan                  4000              25.0
Feb                  3700              27.0
Mar                  3400              29.4
Apr                  3100              32.3
May                  3400              29.4
Jun                  3700              27.0
Jul                  4100              24.4
Aug                  4400              22.7
Sep                  4700              21.3
Oct                  4900              20.4
Nov                  4600              21.7
Dec                  4000              25.0
Total                                 305.6

Had the FTSE 100 stayed at 4000 all year, or if we had invested £1,200 in January rather than £100 each month, we would have ended up with 300 units. But because the market moved up and down we've ended up with a little bit more - 305.6 units in fact - even though the average value of the index has been 4000 over the year. You'd have done even better if the FTSE had fallen from 4000 at the start of the year and then not recovered until the year-end. On the other hand, an index that rose steadily throughout the year would have left us with fewer units.

So, if you're investing regularly, you actually do better when the market has major lurches downwards. It's no surprise really since you're buying your shares more cheaply. What's more, by not jumping in with all your money at once, you spread out your risk. In this case, we've bought our average unit at 3,927, although the index has bounced around between 3,100 and 4,900. That's the beauty of pound-cost averaging!