Explaining pound cost averaging to your clients

With interest rates now above 5% and markets still suffering from periods of volatility, you may have clients who are nervous about investing and keen to have more of their money in what they see as the safe haven of cash. However, from a consumer duty perspective, you need to consider whether cash will give them the best long-term outcomes.

This is where explaining the benefits of pound cost averaging and drip-feeding their money into investments could come in.

Pound cost averaging can:

• Help create a disciplined, systematic approach to investing
• Remove the worry of making lump sum investments at the wrong time
• Provide a smoother, more consistent way into the market
• Help mitigate the impact of falling asset prices

In a nutshell, although pound cost averaging isn’t guaranteed to be the best investment strategy, even during periods of market volatility, it could be a lower maintenance and potentially less stressful approach to investing for them as they won’t have to constantly worry about how markets are performing.

How does pound cost averaging work?

Very simply, it involves making regular payments into investments rather than investing a lump sum all at once. By making regular payments, you’re buying fewer units when prices are high and more when prices are low, essentially averaging out prices. This is why it’s often seen as a good approach when markets are volatile. Plus, it removes the worry of making a lump sum investment right before a market fall.

If you invest a lump sum just before a market fall, you’ll be buying when prices are high, and you’ll miss out on the opportunity to buy more units at a cheaper price. This means that your investment returns are likely to be lower too.

Even experienced investors know that it’s almost impossible to time the market – sell investments just before prices go down and buy them just before they go up. And this is particularly true during periods of market volatility when you could see big rises one day and equally big falls the following day.

So, although with any investment approach the value of your investments can go down as well as up, and you could get back less than you paid in, pound cost averaging can feel like a less daunting way to invest.

A pound cost averaging example

This shows how pound cost averaging works for two different investors over a volatile period in markets.

Investor A invests £1,000 a month over the year, while investor B invests £12,000 in January. Across the year, the market rises and falls with the unit price following the same trend.

By December, investor A has bought over 1,000 more units and paid a lower average price than investor B. In addition, the value of their plan is almost £2,000 more.

Pound cost averaging in rising markets

Of course, there’s no guarantee that pound cost averaging will result in better outcomes than investing a lump sum. And it’s important to understand that in a rising market, investing a lump sum from the start would mean you’d be buying investments at a lower price, which in turn could potentially mean higher long-term returns.

However, ups and downs are part of investing and no one can say with any certainty when markets will stop rising. So pound cost averaging can be a useful approach to make sure you don’t buy at the wrong time and are able to take advantage of market volatility.