Government spending will continue to be squeezed as a result of the consequences of us living longer. The support the state provides us with today may not be as comprehensive in twenty to thirty years from now. It is therefore more of a necessity than ever to build our own nest egg.
Pound Cost Averaging
For new investors, saving monthly is a good way to start – it becomes habit forming. For the price of a good meal, savers can start to plan more effectively for the future.
Investing lump sums is not for everyone for a number of reasons including lack of available funds and fear of getting the timing wrong. Another option is to save small amounts monthly which enables one to avoid second guessing market movement. This method of investing is also called ‘pound cost averaging’
In this hypothetical example, an investor made monthly payments of £100 per month. When the unit price rises the investor bought fewer units and as the price fell the investor bought more units in the fund. As a result the investor’s average cost per unit (£5) was lower than the average market price (£8.30) over the same time period. There will of course be times when the price of units continually rises or falls, in which case the average unit price could be higher or lower than the market average.
Why isn’t everyone investing this way?
Clearly there are advantages to pound cost averaging, including the potential to benefit from volatile or falling markets. However, there are also disadvantages when compared to investing lump sums, such as missing out on the significant growth in a rapidly rising market. The choice of which route to take is a personal one but investing monthly does introduce a “saving discipline” with the result that saving almost becomes second nature. If you are regularly investing a manageable amount you develop a “saving habit” which will stand you in good stead as your lifestyle changes.
It is very difficult without the benefit of hindsight to invest at a low point in the market – and some would say impossible. Even renowned investor Warren Buffett cannot predict the future but he does base his investment decisions on a very simple premise which has helped investors:
“Be fearful when others are greedy and be greedy when others are fearful.”
Investing savings on a monthly basis can take away the “fear factor” that Warren Buffett refers to. Whilst it is still worrying to see your investments take a dip when there is a downturn in the markets, the effect will not be as pronounced as if you had invested a lump sum a day before the downturn started.
OK, I like the idea of investing monthly but where do I start?
The Cofunds fund universe has over 3,000 funds to from which to choose and selecting funds to suit your needs would be a daunting task. For this reason we feature funds in the magazine which are both eligible for lump sum and monthly investing. To demonstrate the effect of investing monthly we have chosen one of the largest and most well-known funds in the UK – The Invesco Perpetual High Income fund.
The High Income Fund, although not particularly volatile, has still experienced the ups and downs of the stock market over the last 10 years. The below bar chart serves to demonstrate the effect of pound cost averaging and how investing monthly over a period of time can affect investment returns. As always, it should be borne in mind that past performance is not a reliable indicator to future returns.
How much can I invest?
In our examples we have assumed an investment of £100 per month. However, monthly contributions can start from as little as £10 per fund. There are many funds available from which to choose, including the Invesco High Income Fund. Take a look at the funds featured in this edition or talk to our client relationship managers who will happy to answer any of your questions.
What if I need to stop or change my contributions?
Investments should be made for the medium to long term – 5 years or longer – although your contributions can be stopped or changed at any time. There is no commitment to a fixed term and your investment is not subject to a qualifying period. Money can be left invested until you want to recommence your contributions or withdrawn at any time without a penalty.
Written confirmation is not required to make changes to your monthly contributions. Your instructions can be communicated by e-mail or by telephone.
In summary, the benefits of regular savings are:-
- Easy to get started – invest from £10 per month
- Flexible – amend your investment choice at any time and withdraw your savings without penalty
- No need to worry about "timing the market" – one of the disadvantages of making a lump sum investment is that no one knows for certain where the market will go next. Will you be buying at the highest point in the cycle or lowest? The averaging effect of making regular investment into stock-markets takes away that concern since you know that you will be buying into your investments at all stages of the market cycle.
I have made my choice- what next?
Once you have decided which fund(s) you want to invest into and whether you are investing inside or outside of ISA, complete the relevant application form (you can download one from the website or ask us to send you one), not forgetting the Direct Debit, and return them to us.
This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in collectives should only be made after reading the Key Investor Information Document, Supplemental Information Document and/or Prospectus. This article is solely for information purposes and does not constitute advice or a personal recommendation. If you are unsure of the suitability of your investment please seek professional advice.