How The Magic Of Pound Cost Averaging Smooths Investment

Stock markets and investors are strange beasts –  fanfares sounded for the Dow Jones bursting through the 20,000 mark in January, but when the FTSE climbed to a modest 6,930 after a break of 16 years, the news was met with a near silence.

Although investors look like they lost big time between the 2008 downturn and the start of 2017, nothing could really be farther from the truth.

Watching the markets rise and fall does not determine profit and loss.

The magic of pound cost averaging comes into play and that’s really where fortunes are won and lost.

Scarred investors

“Rollercoaster markets over recent history have scarred a generation of UK investors. On the other hand those invested in property have seen their assets grow considerably since the dotcom crash, with the UK IPD Total Return All Property Index up 275%, or 8% on an annual basis,” says Oliver Smith, of London’s IG Group.

Investors in for the long haul benefit from reinvesting dividends and ride the storm with pound cost averaging.

Smith worked out that if an investor bought shares as the FTSE topped out in 1999, the headline gain is just 4.5%, but with dividends reinvested, this soars to 78%.

“In short, reinvesting dividends added 3.5% to returns each year,” he said.

Pound cost averaging, Smith explained, helped investors buy more shares when they were cheaper.

Warning for lump sum investors

“If you invested £100 pounds into an index Exchange Traded Fund which cost £2, you would acquire 50 shares in month one,” he said.

“If the price of the index ETF subsequently fell to £1.75, you would be able to buy 57 shares with the same amount of money. Should the price of the index ETF eventually rally to £3, the initial investment at £2 would record a 50% gain, and the shares bought at £1.75 would have a 71% gain.”

Smith added a warning – pound cost averaging works well for investors drip feeding money into a market, such as pension and ISA savers, but is unlikely to offer any profit to someone staking a lump sum as a one-off transaction.

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