What is pound cost averaging?
Guide Summary
- Pound cost averaging means spreading your investments out as regular payments to reduce exposure to a single market price.
- This helps you to smooth out the ups and downs of the market.
- The benefit of this is that you don’t need to try and ‘time the market’, potentially leading to more extreme portfolio fluctuations.
Understanding pound cost averaging
Pound cost averaging means investing the same amount on a regular basis. As a result of making steady investments, your invested ‘pounds’ are exposed to many different market prices, rather than one (potentially) high price.
This price averaging helps to smooth out the ups and downs of the market, and potential exposure to a case of bad market timing.
An example of pound cost averaging
Imagine you decide to invest £200 a month on the first day of each month into your portfolio. Here’s how it might look invested over a fluctuating market environment:
- January — Share price: £10. Shares purchased: 20
- February — Share price: £8. Shares purchased: 25
- March — Share price: £12.50. Shares purchased: 16
- April — Share price: £10. Shares purchased: 20
You invested a total of £800 over four months, acquired 81 shares, at an average market price of £10.13.
However, because you invested consistently over this period and took advantage of the price dip in February, your personal average cost per share was £9.88.
You avoided the risk of investing a single lump sum of £800 in March when prices were at their highest.
Benefits of pound cost averaging
- Reduces market timing risk — spreads your investments out over time, reducing potential exposure to a high market price if you invested a lump sum.
- Disciplines investor behaviour — automating regular investments removes emotion from the investment process and encourages long-term thinking.
- Lowers the average cost per share — your fixed investment naturally buys more shares when prices are low and fewer when they are high.
- Makes investing accessible — ideal for those who don’t have a large lump sum to invest upfront, and want to invest small amounts regularly.
- Take advantage of volatility — market dips and downturns become beneficial because they allow your regular investment to purchase assets at a discount.
What is lump sum investing?
The opposite of spreading your investments out using pound cost averaging is lump sum investing — the ‘all in one go’ approach.
Instead of smoothing out the ups and down of the market by investing little and often, a lump sum investment can act differently. By entering into the market at one price, you may be buying in at either a high or low price.
Investing at a high price, the market could dip, causing immediate loss in portfolio value. Historically markets have trended upwards, so staying the course and not reacting to short-term fluctuations is crucial. That said, this may be one reason that lump sum investing is less suitable for new investors.
At a low price, investors may benefit from immediate portfolio growth. However, timing the market has historically proved difficult, and this is why many investors opt for pound cost averaging instead of trying to get in at a low price with a lump sum.
So, which is actually better? There are arguments for and against both pound cost averaging and lump sum investing. Looking purely through the lens of returns, research suggests that taking advantage of time in the market leads to greater returns and potentially lowers your costs over the long term — if you are able to use a lump sum to invest and stay the course.1
See our full guide on behavioural investing and common mistakes.
Adapting pound cost averaging to your financial goals
Pound cost averaging isn’t a ‘one size fits all’ strategy, and investors can adapt contributions and investments to suit their needs:
- Aggressive strategy — might focus on more frequent investments into higher risk assets and sector specific funds, accepting greater risk of short-term losses but willing to stay the course.
- Defensive strategy — might focus on steady investments into dividend paying assets, bonds or cash equivalents.
See our full guide on aggressive and defensive investing strategies.
Pound cost averaging summary
Pound cost averaging can help smooth out market volatility and remove the stress of trying to ‘time the market’. It can help lower your average cost per share over time by automatically buying more shares when prices are low and fewer when they are high.
Practicing ‘pound cost averaging’ is not a guarantee of returns, but if you want to follow a popular principle of investing that uses time as a tool, it’s a great place to start.
Lump sum investing can help you take advantage of time in the market, but buying at one price might leave you exposed to short-term price swings — so staying the course is important.
Next in this series: Investment time horizon — how time is your best friend when it comes to setting investment goals.
When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than your original investment. Chip does not offer financial advice and this should not be considered as a personal recommendation.
