When it comes to investing, there’s a great deal of terminology to get your head around – and some of it sounds far more complex than it actually is.
One such term is “pound-cost averaging”, also referred to as “drip-feeding”. So what actually is it – and does it work?
What is pound-cost averaging?
Put simply, pound-cost averaging is choosing to invest the same smaller amounts on a regular basis, rather than investing a single lump sum all in one go. As an example, you may receive a lump sum of £12,000 as an inheritance. Rather than invest the entire £12,000 at once, you instead split that sum out and invest £1,000 per month for 12 months.
The advantages of pound-cost averaging
There are many reasons why some investors are fans of this approach:
- It can promote discipline: it encourages you to invest little and often, putting money away for the longer term.
- It can regulate emotional decisions: By doing the same thing each month, you can take away some of the emotional decisions that you may be used to making with big price swings.
- Take advantage of volatility: If you invest your lump sum before a big market downturn, you could miss out on cheaper shares. By investing during downturns you could potentially see bigger returns when the market picks back up.
- Averaging your costs: While shares will be more expensive when your market is performing strongly, they’ll also be cheaper when performance isn’t so great, averaging out your costs.
The disadvantages of pound-cost averaging
While there are potential advantages to pound-cost averaging, there may also be some down sides:
- Reduced and delayed potential returns: If the market is rising, sticking to your guns and investing monthly may mean that potential returns could be reduced or delayed.
- Keeping your cash accessible: If you’re investing monthly, you’ll need to keep your monthly investment amount somewhere that is easily accessible. This could be in an easy access savings account, for example, where interest rates could be significantly lower than what you could potentially earn elsewhere.
If pound-cost averaging is an approach you have tried, we’d love to hear about your experiences!
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