The Magic of Pound Cost Averaging

So what is pound cost averaging?

There aren’t many free lunches when it comes to investing but there are at least two that we can take advantage of relatively easily. The first is diversification which is covered in another article and the second is the magic of pound cost averaging.

It’s definitely not as complicated as it sounds

Pound cost averaging is a relatively simple concept and yet when I speak to many people who’ve been investing for a while they often claim to be unaware of it. I’m not sure why. Maybe it’s because they’d rather concentrate on trading instead of investing but it seems crazy to me not to make this part of your money-making strategy.

At its most basic what you’re doing is smoothing out the ups and downs of the investing cycle. For various reasons, a stock will fluctuate up and down throughout the life of the company, month to month and even day-to-day. This could be the result of the industry within which the stock resides simply being out of favour with the wider stock market, causing the value to fall, or they could have had an unusually profitable quarter which has driven the value up.

Now you could try to buy on the dips and sell on the highs, but accurately timing the market is next to impossible unless you’ve invented your very own time machine or have a genuine working crystal ball. In which case stop reading this immediately and go and buy a lottery ticket!

Regular investing

However, there is a way to take advantage of the lows in the value of a stock without having to worry If you’re going to be able to invest at the right time. By automatically putting your money into a quality stock on a regular monthly basis you’ll still occasionally buy on the highs, but you’ll be able to even this out by also buying on the lows.

Most trading platforms will allow you to purchase additional stock on a rolling monthly basis for a much lower cost than buying a single amount in one go. The platform I use has a purchasing fee of £12.50 per share plus 0.5% stamp duty, whereas if you buy additional shares regularly each month you’re only charged £1.50 per transaction. Over the course of a few years, this can be a relatively inexpensive way to build up your holding whilst taking full advantage of pound cost averaging.

Now I can’t comment on all stock brokers but the platform I use, Hargreaves Lansdown, doesn’t allow every stock in existence to be purchased in this way, and in fact, is currently limited to stocks within the FTSE 350 and certain Investment Trusts. However, for me, this isn’t a problem as Investment Trusts have become the vehicle of choice for my money-making journey.

So to conclude, if you want to invest for the long-term, yes you should have a diversified portfolio, but you also need to regularly pay in each and every month to take advantage of the cycles of the stock market. And then most importantly, try to stop worrying what your shares are doing every day. Go and have a cup of tea. You deserve it!

FinanceFanatics

Personal finance blogger who's fanatical about financial freedom, investing and making money in the UK

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