When it comes to saving for your retirement there is often a tricky dilemma you will come across, should you invest all your money in one go or use the approach of pound cost averaging?
Hopefully by now you are convinced you need to invest in the great companies of the world (global equity funds) if you truly want to achieve your retirement savings number and never run out of money.
As we know, when it comes to investing in the global stock markets, the value of these great companies falls and rises every day. You might feel like giving up investing altogether if the market drops 10%-20% the day after you invested.
So, let’s look at the best approach of feeding your money into the worlds greatest wealth making machine.
What is pound cost averaging?
Pound cost averaging, known as dollar cost averaging in the US, is the concept of investing the same amount of money on a regular basis rather than all in one go.
The regular basis usually means monthly as most people receive their salary from work monthly, so it is easy to carve out some of your wages for retirement saving.
Along with compound interest, pound cost averaging is actually one of those magical wonders of the world that can lead to great investment success without you needing to do anything. It’s so simple but so effective. It’s actually the best investment manager you will ever find.
In the following example a person saving for their retirement is investing £1,000 a month into a global equity fund.
Over the 2 years the unit price of the fund fell significantly which would have put a lot of people off investing.
Although the price recovered, after two years the price is still the same. Therefore, investors who are not using pound cost averaging would have seen their investment do nothing for two years, that’s if they didn’t panic and sell out.
For the pound cost average investor something magical has happened. When the unit price of the fund went down their monthly investment bought more units. This has resulted in them actually making a 23.65% annualised return.
We know that timing the market is impossible to do left to our own devices however pound cost averaging does actually achieve perfect market timing. It automatically buys more units when they are cheap and less units when they are expensive. This is a proven method for great success but unfortunately what most people don’t do. Most people do the opposite and that is why most people are not wealthy.
When you pound cost average you embrace volatility. You want the market to decline as it means you can buy more and more units.
The only time you should do pound cost averaging
So, it looks like pound cost averaging is the clear winner when it comes to investment timing but hold on, this is not the end of the story.
Pound cost averaging works when you receive money to invest on a regular basis like a salary from work or a regular gift from a parent.
If you receive a lump sum of money on a one-off basis, for example, a bonus, an inheritance, divorce payment, compensation payment or tax-free lump sum from a defined benefit pension then you are likely to be better off investing all this money straight away.
The global stock market goes up around 77% of the time. Therefore, if you don’t invest because you feel the market is high or you decide to pound cost average then you are hoping the market falls dramatically over the next two to three years to ensure that you are better off than just investing it all in one go now.
This is the wrong kind of market timing. You are making a bet with only 23% chance it will happen.
Remember the following rule:
If it’s monthly money, pound cost average but if it’s one-off money invest in one go.
If you are a particularly cautious person then you may still decide to invest your lump sum over a number of months however, if you are already scared at this point, you need to decide whether investing really is for you.
If you would like to understand your retirement number, the amount you need to save for a successful retirement, then please get in touch for a free no obligation 15-minute call. We would be happy to review your position, explain where you stand and what you need to do to get the outcome you desire. We have created hundreds of happy and protected retirements over the years. This could be you too.
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.