What is pound cost averaging? We break down how it could help in a market downturn.
Originally published on moneybox.com
While it’s tempting to take action in a downturn, one of the best ways to ride the ups and downs of the market is to have a plan and stick to it. Know your longer-term goals, invest regular amounts each week and benefit from pound cost averaging.
What is pound cost averaging?
If you invest regularly you benefit from the average price of the investments you buy over time – known as pound cost averaging. So, when you continue to contribute regularly, even during a downturn, you will buy shares at lower prices, which could be beneficial in the long-term.
Jumping in and out of the market will probably have a negative impact on your returns
While in theory, it is possible to time the market – to sell just before prices go down and buy back just before they rise – in practice, it’s almost impossible to do so and you’ll lose lots of sleep trying!
Selling up and being out of the market can be extremely costly too. For instance, if you invested in the stock market (FTSE All-World GBP) from 2008 through to the end of 2019 and never made a withdrawal, you’d have made an average return of 9.3% per year. Your £1,000 would become £2,915.
However, if you tried to ‘time the market’ you might have missed the best trading days. Even though your instincts would tell you otherwise, getting out of the market can be the costliest mistake of all. A JP Morgan study found that 6 of the 10 best days in the market (based on the S&P 500 index) over a 20 year period occurred within 2 weeks of the 10 worst days.
We have seen examples of this in the last few days. Markets, which have been rocked in recent weeks by uncertainties due to the Covid-19 outbreak, have been boosted by never before seen stimulus measures from governments around the world. This has led the S&P 500 index to be up 9.4% on March 24 from the day prior, its biggest one-day gain since 2008. The Dow Jones Industrial Average index also soared 11.4% on the same day, making this its strongest showing since the Great Depression in 1933*.
Benefit of pound cost averaging
Regular investing each week or month, no matter what the state of the market, will teach you a non-emotional approach. You’ll buy low, high and everything in between and you’ll capture the average return of the market – 9.3% per year historically**, which over time could lead to you doubling your money about once every decade. But remember, past performance is not a reliable guide to future performance.
So, what next?
As an investor, it’s important to be prepared for the ups and downs of the stock market. If you invest weekly, like hundreds of thousands of Moneybox users, the smartest decision you can make is to continue as you were, know your longer-term goals and continue to benefit from pound cost averaging.
Remember, past performance is not a reliable guide to future performance. All investing should be regarded as longer term. The value of your investments can go up and down, and you may get back less than you invest.
*Source: Financial Times
**Over the last 10 years (start of 2008 – end of 2019), the FTSE All-World GBP has averaged an annual return of 9.3%