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INVESTING EXPLAINED: What you need to know about the cost of the pound, an ideal way to limit the risk of investing in stocks as a beginner
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In this series, we break through the jargon and explain a popular investment term or theme. Here is the pound cost average.
What is the average cost of pounds?
With this simple way of investing, you trickle money into the stock markets every month or quarter, instead of entrusting a lump sum from the start.
For example, if you have $3,000 left, you would invest $250 per month, rather than wagering the entire amount.
The aim is to mitigate the damage from falling stock markets by lowering the overall average cost of your investment, as each regular investment buys more units during times of market weakness and fewer units when markets are high.
Risk diversification: you trickle money into the stock markets every month or quarter, instead of entrusting a lump sum from the start
Who should invest in this way?
Pound cost averaging is an ideal way to limit the risk of investing in stocks as a beginner. It’s good to have a routine in place – to “cement” good behavior, as some would say.
But it also suits seasoned investors who are wary of the direction of the stock markets, but don’t want to miss out on opportunities for profit – and also want to be positioned for an upturn.
They view the trickle of money into markets as good discipline, recognizing that you should probably buy on the way down to benefit from a full recovery.
What is the main benefit of this?
It removes any emotion when investing in stocks and shares – you are also more protected from volatility. You don’t have to wonder if you have chosen the most favorable moment to buy. Instead, commit to a regular contribution whether prices rise or fall. You should sleep easier.
Is there a downside?
Yes, if the stock markets are rising during the period you are investing it would have been more profitable to invest the whole £3,000. But at least you gained some benefit – and spared yourself anguish.
Where does the expression come from?
The many benefits of this system were first popularized in The Intelligent Investor, an American book published in 1949, where it was called “dollar-cost averaging” and described as a means of achieving a “satisfactory general price.” for your shares.
The author of the book was Benjamin Graham. Today, he is best known as the person Warren Buffett, the manager of the mighty Berkshire Hathaway fund, considered his investment guru.
Buffett says his own philanthropy was inspired by admiration for Graham’s generosity with ideas and more.
Is value averaging different?
Yes. With this system, you change the amount you invest each month or quarter, contributing more when prices fall. Some fans set a goal for portfolio growth and put in more money if they don’t meet their goal. There is more work involved, and more risk.
How would I start?
Most fund management groups offer monthly savings plans. You can also open an account with providers such as Nutmeg, choosing the level of risk you want to take and your long-term goals.
Platforms (online investment supermarkets) such as AJ Bell offer monthly savings shares and Isas (individual savings account) shares. The annual Isa fee is £20,000.
Average pound cost can be an incentive to make the most of this tax benefit.