Benefits of regular investing explained
Getting started with investing can seem daunting, especially as investment literature is littered with warnings that ‘the value of your investment could go down as well as up’.
It’s therefore understandable that anyone considering putting big chunk of money into an investment might be put off doing so because of the worry that it could fall in value straight afterwards.
Whilst there’s no way of removing investment risk altogether, putting in smaller amounts regularly can help smooth out market highs and lows. It can also make investing more accessible if you don’t have a lump sum available to invest.
Potential rewards of pound cost averaging
Drip-feeding money into your investments gradually means that you buy more shares or types of asset when their price is low, and fewer when their price is high.
As you’re buying across a range of prices, you end up paying the average price over that period, helping smooth out market volatility, known as ‘pound cost averaging’.
For example, imagine you invested $100 a month in an investment fund. If the fund’s unit price is $5 in the first month, your $100 investment would buy you 20 shares. If the share price dropped to $3 for the next five months, your same $100 investment would buy you 33 shares in each of these months. If the unit price rose to $7 for the remaining four months, the same £100 investment would only buy you 14 shares in each of these months.
In total, you’d end up buying 241 shares over the 10-month period if you invested $100 a month. If, however, you’d invested a lump sum of $1,000 at the start of the 10-month period when the share price was $5, you’d have 200 shares.
If the unit price fell to $5 again at the end of the 10-month period, your initial $1,000 lump sum investment would be worth the same, whereas if you’d invested regularly, your 241 shares would be worth $1,205.
Of course, this is just an example, and if the share price had risen consistently over the 10-month period, your lump sum investment would be worth more than if you’d invested regularly. However, as markets rarely move in a straight line, paying the average price over a long period often reaps rewards.
Weighing up the pros and cons
There are some downsides as well as benefits to regular investing.
When markets are performing strongly, for example, if you’d chosen to invest a lump sum, this full amount would be able to benefit from any growth. If you’re only paying in a smaller amount each month, then only the portion already invested will benefit.
That said, investing regularly means you don’t end up trying to ‘time the market’, buying shares when prices are low and selling when they’re at a high. Given how volatile markets can be, this is exceptionally difficult even for investors with decades of experience to get right. If you have a monthly payment set up to leave your account each month, you’re less likely to agonise over whether it’s exactly the right time to invest.
Your money will instead be going in automatically every month, with the hope that even though there may be some bad months, over the long-term, the good months will outweigh these.
Drip-feeding money regularly into investments also helps remove some of the emotion from investing, enabling you to adopt a disciplined approach and to focus on the long-term rather than being distracted by bouts of volatility.
It also means you might be able better resist the urge to make any knee-jerk reactions, pulling your money out when markets are turbulent and turning paper losses into real ones.