It’s almost four years since the Covid-19 pandemic began, yet economies around the world are still feeling the effects. This has caused significant volatility in the stock market, and this may have knocked your confidence when it comes to investing.
During a period of market volatility, it is natural to be cautious about where you put your wealth. For example, you may be worried that if you invest right before a market downturn, you could experience significant losses.
As a result, you might decide to wait until markets stabilise and it appears less risky before you invest. This option may seem especially attractive considering that interest you can earn on your cash savings has risen considerably in recent months.
You may feel that it is “safer” to keep your wealth in a savings account for the time being rather than risk investing in a volatile market. Unfortunately, that may not be as safe as you perceive because, according to the Office for National Statistics (ONS), inflation was 6.7% in the 12 months to September 2023.
In comparison, Moneyfacts reports that the best easy access savings account interest rate is 5.10% on 4 October 2023. So, while fixed-term savings accounts could give you a marginally better rate, there is a strong chance that your wealth could lose value in real terms if you leave it sitting in a savings account.
However, if you can overcome your apprehension about investing during a period of market volatility, you may be more likely to see long-term growth that beats inflation.
Fortunately, a simple change to the way that you invest your wealth could alleviate some of these fears and help you feel more confident about investing.
Many people invest a lump sum once or twice a year, for instance. But it may be more sensible to invest at regular intervals throughout the year, using a method known as “pound cost averaging”.
Read on to learn some of the interesting benefits of drip-feeding funds into the market.
“Pound cost averaging” can help smooth out fluctuations in price
“Pound cost averaging” is an investment strategy that involves drip-feeding funds into the market so you can potentially smooth out any fluctuations in price.
Instead of investing £12,000 in the stock market in one lump sum, for example, you could pay in £1,000 a month for the entire year.
If you were to contribute a lump sum, you could easily end up investing the full £12,000 when unit prices are high. This could make it more difficult to generate positive returns as the value of your investment may be more likely to drop. Additionally, you may not be able to buy as many units with your investment.
When investing a large lump sum, ideally you would want to invest the full amount when prices are at their lowest point, so you can purchase more units and potentially benefit from more growth in the future. However, you rely mainly on luck to achieve this as it is notoriously difficult to predict market movements.
Pound cost averaging allows you to invest at multiple price points throughout the year, so you purchase some units when prices are high and others when prices are low. Over the course of the year, this averages the cost of your investment.
When you take this approach, you are less reliant on “timing the market” and investing a lump sum at the correct time.
The following example demonstrates how two investors with the same £12,000 could see different returns, depending on how they buy into the market:
As you can see, while both investors contributed the same amount, Investor A was able to purchase more units because they invested in months when prices were low.
On the other hand, Investor B invested their full £12,000 when costs were relatively high. Consequently, they did not purchase as many units as Investor A and the total value of their investment was lower at the end of the year.
Naturally, these figures are only illustrative and the results from pound cost averaging vary depending on market fluctuations. That said, even though both investors would have made a profit, Investor A saw increased gains because they were able to benefit from low unit prices by investing regularly.
This can make investing feel like less of a gamble, so you can be more confident, particularly during a period of market volatility.
The interesting benefits of drip-feeding funds into the market
Take a less stressful approach to investing
Investing a large lump sum each year can be incredibly stressful because there is often a concern about choosing the “wrong time” to put your money into the market.
This is particularly true during a period of market volatility, and you may be concerned that the market will dip soon after you invest. This would likely mean that your investment immediately loses value, and you miss an opportunity to purchase more units when prices fall.
When you drip-feed funds in each month, you don’t have this same pressure. You are only investing a small portion of your wealth at a time, which may feel less daunting than a large lump sum.
Additionally, you are investing regularly, so it doesn’t feel as though you only have one chance to pick the “right” time.
Smooth out market fluctuations
Another key benefit of spreading out your investment is that you can smooth out market fluctuations. You invest when prices are low and high, so the average unit price balances out over the course of the year.
As a result, you may be able to mitigate the effects of any big fluctuations in price. This is because, if you were to invest a lump sum right before a market downturn, you would experience losses on the full amount.
However, with pound cost averaging, you only invest a portion of your wealth before the markets dip. Fortunately, in subsequent months, you may be able to purchase more units when the prices are lower.
When the markets recover, you could see more growth because you invested when unit prices were low. This means you might be able to balance out your earlier losses.
Be more disciplined about investing
Consistency is important when saving and investing your wealth. Unfortunately, if you are prone to panic during times of uncertainty, you may find that you neglect your investments. This could make it more difficult to meet your long-term goals.
If you find it challenging to be consistent with your investments, drip-feeding funds may be a useful solution. By taking this approach, you may find it easier to stick to your investing goals.
Get in touch
If you want to ensure you continue working towards your long-term goals during a period of volatility, we can explore the benefits that pound cost averaging might present for you.
Please give us a call on 01276 855717 or email firstname.lastname@example.org today.
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
Approved by the Openwork Partnership on 10/10/2023