What is pound cost averaging and is it beneficial?

Deciding when to invest can be challenging, particularly when markets are constantly fluctuating. If you have a lump sum, say from an inheritance or work bonus, it may be tempting to invest it all at once. However, this approach requires steady nerves and a hope you time the market to buy shares just before they rise in value, which is very difficult to do.

An alternative strategy called pound cost averaging (PCA), also known as drip-feeding, can offer a solution to this problem and reduce the stress of choosing the right time to invest. First coined in 1949 by financial analyst and investor Benjamin Graham in his book "The Intelligent Investor," PCA involves investing a fixed amount regularly to achieve a satisfactory overall price.

Instead of investing £10,000 all at once, you would invest £500 monthly over 20 months. This method allows you to spread your investments over time, reducing risk, and potentially increasing returns. But is it the best strategy for all investors? Here we highlight the pros and cons:

Benefits of PCA:

• Reduces impact of market volatility: Regular investments mean you buy more shares when prices are low and fewer when prices are high, smoothing out market ups and downs.
• Disciplined investing: Regular investing encourages discipline and helps build wealth steadily over time.
• It removes the stress from making lump sum investments: If you’re new to investing your natural inclination may be to invest when markets are rising and not when they are falling. If you put your all your money in at the wrong time, then it may not lead to the best outcome.

Disadvantages of PCA:

• Opportunity cost: In prolonged bull markets  (where stock prices consistently rise), PCA may not capture the full potential of market gains, missing larger, one-time investment opportunities.
• Impact of inflation: Keeping money in cash while drip-feeding into investments can lead to value loss due to inflation.
• No guaranteed returns: PCA does not guarantee higher returns or a better outcome; all investing carries risk and investments can still lose value.

While the jury is still out on the overall effectiveness of pound cost averaging or drip-feeding, the importance of maintaining a regular savings habit and taking the emotion out of investing cannot be overstated. PCA may be a good way for cautious, new investors with a lump sum to approach stock market investing. However, it may lead to missing out on returns during bull market runs and investors are likely to encounter market volatility once fully invested. 

Regular investments from income over a sustained period can help mitigate market volatility by buying assets at different price points, potentially lowering the average cost. Timing the market is fraught with difficulty, even for experienced investors, and many people buy when markets are rising and sell when they are falling. Regular saving can remove emotions from the equation, often with beneficial outcomes. This strategy also encourages disciplined saving and investing habits, making it easier to stay committed to your financial goals.

Evelyn Partners offers combined wealth management services with professional advisors and investment managers who can help you work towards your financial objectives.

To learn more about how PCA could work for you, please book an appointment or speak to your usual Evelyn Partners contact.