Money Mistake 5 Timing Pound Cost Averaging

Pound Cost Averaging - Money Mistake 5 - Investing At The Wrong Time In The Wrong Thing

Other Mistakes: 1.  Going Direct  2.  Not Bartering  3.  No Reviews  4.  Poor Quality Adviser

Avoid Headlines “We’re Great, Look At Our Great Performance”

Why do some investments go down when many markets have fallen in value but in exactly the same falling market, some investments actually manage to go up in value?

• Collective or Pooled Investment - Investing in the investment markets can be done in many different ways.  By investing on a regular basis into market linked funds you benefit from the ups and downs that are associated with property, assets, bonds, gilts, stocks and shares.
• Low market = more units - Each time you pay a premium it buys a certain number of units in your chosen fund.  When the market is low, the price to buy each unit is also generally low, meaning that you buy more units for your money.
• High market = less units - When the market is high, the price of units is higher, meaning you buy fewer units for your money.  This is known as 'pound cost averaging' and is good for people saving on a regular basis.  As the stock market goes up, so does the value of the units you hold.

Investing at the wrong time:

If market units were valued at £1 each, you would buy 10 units for a £10 investment.  However, if the market fell and the price of each unit also fell to 50p, the next £10 you invested would buy 20 units.  If the market recovered and each unit was valued at £1 again, you would have 20 units instead of 10.

Volatile markets can be bad news for investors if you time it badly with a lump sum investment i.e.  you invest when the market is high and sell out when cheaper.

But, for regular monthly premium savers, volatile markets may be good news:

Let us look at the following example over a six month volatile market - let's assume that you invest £50 per month in the 'XYZ' fund who's starting share price is £2.00.

• Month 1 - You invest £50.  The unit share price is £2.00.  You therefore have bought 25 new units.  Total units owned = 25.
• Month 2 - You invest £50.  The unit share price has fallen to £1.75.  You therefore have bought 28.6 new units.  Total units owned = 53.6.
• Month 3 - You invest £50.  The unit share price has fallen to £1.50.  You therefore have bought 33.3 new units.  Total units owned = 86.9.
• Month 4 - You invest £50.  The unit share price is now £1.00 (disaster - the market has crashed).  You therefore have bought 50 new units.  Total units owned = 136.9.
• Month 5 - You invest £50.  The unit share price is £1.50 (semi-recovery).  You therefore have bought 33.3 new units.  Total units owned = 170.2.
• Month 6 - You invest £50.  The unit share price is £1.75.  You therefore have bought 28.6 new units.  Total units owned = 198.8.

So, over the six month period, the investment market has done poorly.  The unit price is down 25p overall.  You have invested £300 to your dismay in a falling, volatile market.  

What is our investment now worth? Pound Cost Averaging

At Month 6, you own 198.8 units at £1.75 per unit.  The value is £347.90 (198.8 X £1.75).
You have made a gain in a market that has fallen over a six month period.

This is the effect of 'pound cost averaging'.  It illustrates the principle of buying more units in a falling market, i.e.  buy low, sell high.

Conclusion - The Mistakes:

This is not ‘rocket science’; it is simple mathematics.  Let us say an adviser shows you figures where a particular fund has done well over the last few years.  Most people invest when it is too late, when they have already missed the rise, when they feel safe because they see headlines about great investment performance.  You have ‘missed the boat’.

IN A RISING MARKET (i.e.  one that has ‘bottomed out’ and is in recovery) - INVEST LUMP SUMS.  

REACT TO HEADLINES: Look out for danger signals on television or in sites like this with headlines such as "The stockmarket reached another all time high today", “Property values hit record high”.  
THIS IS THE TIME TO PROFIT TAKE – i.e.  GET OUT.

IN A FALLING MARKET - INVEST REGULAR AMOUNTS - pound cost averaging.  

WHEN THE MARKET HITS THE BOTTOM AND STARTS TO RECOVER - GET BACK IN WITH LUMP SUMS IMMEDIATELY.  

But when will that recovery be?  The ‘million dollar’ question.  This is not exact.  As soon as you see the headlines:"Stockmarket crash”, “Property slump”, Market falling”, “free fall”, “billions wiped off”, make the decision, do not wait.  You will miss it.  

It could fall even further down or rise even higher after you have made your decision and you lose out a little.  Significant market falls and rises happen over a few days or weeks, it is impossible to be exact, you may have to wait a few weeks or even months to see profit.

YOU ARE NOT TRYING TO KEEP PERFECT TIMING HERE, MERELY TO BE IN THE RIGHT PLACE AT THE RIGHT TIME.  BUY LOW - SELL HIGH.