Pound Cost Averaging: The Psychology and Why it Works

Pound cost averaging sounds like investment jargon, but it’s actually a powerful tool. Instead of investing your money all in one go, you drip-feed it into the market over a period of months. This has potential benefits both from a financial point of view and psychological one. 

So, how does it work, and how can you incorporate pound cost averaging into your investment plan?

What is Pound Cost Averaging?

The idea behind pound cost averaging is simple. Cash is invested in the market over a specific period on the expectation that the price of the investments purchased will likely rise and fall. Often thought of as a strategy predominantly for regular contributions, e.g., monthly, it can be equally effective for lump sum investors.

Let’s take a very simple example:

Full Investment

Phased Investment

Of course, if share prices had steadily risen, the lump sum investor who went straight into the market would have ended up with a larger pot. However, while prices tend to increase over the longer term, this rarely happens in a straight line. We expect to see ups and downs on a monthly basis. 

The Psychological Benefits

Pound cost averaging is also a useful tactic from a psychological perspective. 

There is no best or worst time to invest as price fluctuations happen daily. Trying to time the market is not only mentally draining, but it is also rarely effective. By the time the public becomes aware of something that could affect a share’s or even a fund’s value, it is already priced in. Any advantages gained due to market timing will often be the result of luck rather than skill and are unlikely to be sustainable for the long-term.

You may wish to consider this if you are investing a large amount or if you are nervous about investing all at once.

Other Ways to Boost Your Returns

Pound cost averaging can boost your returns over the longer term, as well as mitigating some of the risks. However, there are a few other tips you can use to improve your returns:

  • Compound growth – this means that you receive growth not only on your initial capital, but also on all of the returns you have made. This can exponentially increase growth potential. 
  • Reinvest dividends – if you reinvest the income made on your investments, this can provide an added boost to your compound growth.
  • Invest across the market – deciding what to buy and sell takes time and energy, and does not always yield the best results. Investing in a diverse range of assets over the whole market allows you to benefit from growth, while avoiding too much concentration in one area.


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Important Information

The contents of this article are for information purposes only and do not constitute advice or a personal recommendation. Investors are advised to seek professional advice before entering into any investment arrangements.

Please also note that the value of investments and the income you get from them may fall as well as rise, and there is no certainty that you will get back the amount of your original investment. You should also be aware that past performance may not be a reliable guide to future performance.

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