The benefits of investing on a regular basis over the long term
With the costs that children will face as they enter adulthood – such as attending university or a deposit sum for a first home – rising every year, there has never been a more important time to start making financial provision for your child to help give them that all important head start in life
Investing for your child is a long term commitment – for example, a Child Trust Fund account runs for 18 years. For an investment plan linked to company shares, one of the hardest things to judge is when to invest your hard earned money. Unfortunately there is no easy answer. Investing a lump sum in one go exposes you to the very real risk of a loss if the market falls. Meaning, you could spread your investment over a long period, meaning you balance your exposure to falling markets with a similar exposure to rising markets. This technique is known as “Pound Cost Averaging”.
How does Pound Cost Averaging work?
Investing regularly means your same regular amount buys more shares when prices are low, which helps to balance out the lower number of shares it buys when prices are high. This way, over time, the effective cost of the shares could even out and the average price you pay could be lower than if you had invested one lump sum at a time when prices were high. So, you don’t need to worry about getting the timing right, as you would if investing a single lump sum.
So does this reduce the risk in a volatile market?
Pound Cost Averaging is actually a strategy that can benefit from a volatile market. In a falling market your payments buy more shares, which means when prices rise, you have more shares to benefit from the upturn. Of course, investing regularly doesn’t guarantee you’ll make a profit, or protect against losses. And you might not make the most of the growth potential offered by a rising market as you could do by investing a lump sum at such a time. However, Pound Cost Averaging can help smooth the effect of market changes on the value of your investment over the longer term.
Is regular investment right for me?
Investing a fixed amount at regular intervals, for example by direct debit, even with the potential advantages of Pound Cost Averaging may not be right for everyone. It requires you to make a regular commitment over a longer period and to keep investing even during periods of market decline. However, for those willing to stay the course this strategy should help smooth out the effects of short-term market fluctuations.
A hypothetical example of investing monthly compared to making a lump sum investment:
|Rising or falling market||Month||Amount invested(regular)||Amount invested (lump sum)||Share price||No. of shares purchased (monthly amount)||No. of shares purchased (lump sum)|
|Total amount invested||£288||£288|
|Total number of shares purchased||81||48|
|Average price of each share||£5.58||£6.00|
|Share price||Monthly amount||Lump sum|
|Effective cost of each share to you||£3.56||£6|
|Value of shares at end of month 12||£1||£81||£48|