Is Pound-Cost Averaging Overrated?

Investing set amounts at regular intervals can reduce risk but may lead to lower returns compared with the lump-sum approach

Adam Zoll 13 March, 2013 | 1:00PM

Question: 

Every year I add money to my ISA in a lump sum. Would I be better off using pound-cost-averaging over the course of the year?

Answer: 

Pound-cost-averaging, which is a technical term for buying shares of a stock or fund in equal pound amounts and at regular intervals, is assumed by many investors and financial pros to be the best way to invest. The advantages are clear: by investing a given amount over time and in equal-sized chunks rather than all at once, the investor ends up buying more shares when prices become cheaper and fewer when they become more expensive.

For example, let's say you have £1,200 in cash to invest. Rather than invest all £1,200 at once, you could invest £100 per month for a year. Now let's say the fund you're investing in sells for £10 a share in the first month but drops to £5 a share in the second. Using the pound-cost averaging method, you would end up buying 10 shares in the first month, before the market drop, but 20 shares in the second, after the drop. Had you invested the entire £1,200 in the first month you would have owned 120 shares, which, in month two, would have declined in value to £600. In this way, pound-cost averaging helps reduce an investor's exposure to a potential market downturn, a danger inherent in the lump-sum approach.

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The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author

Adam Zoll  is an assistant site editor with Morningstar.com, the sister site of Morningstar.co.uk.

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