It’s a simple concept, and for investors who are a little unsure when starting out it can be a good investment strategy to build wealth and make money.

1.     A Simple Illustration of Pound Cost Averaging

The concept is simple. Invest small amounts and relatively often, but contrary to popular opinion this does not always mean monthly.

For simplicity let’s say you had a lump sum of £5000 to invest in five monthly instalments and all in the same company. In reality you would not do this, but this example is just for illustrative purposes only. 

Each share in the fictional company costs £1. 

• In month 1 you invest £1000 and have 1000 shares worth £1 each.
• In month 2 you invest £1000 and have 2000 shares worth £1 each.
• In month 3 you invest £1000 and have 3000 shares worth £1 each.
• In month 4 you invest £1000 but the share price drops to 50p a share, so you get 2000 shares in month 4 for your £1000. You now own 5000 shares.
• In month 5 you invest your final £1000 but the share price has returned to the previous £1 a share price, so you only get 1000 shares this month with a total pot of 6000 shares.

How much is your investment of £5000 worth by the end of month 5?  The answer is £6000. You are £1000 in profit.

So what would have happened if you had invested all of the money as a lump sum in month 1? Your investment by month 5 would be worth what it was at the start, £5000.

2.     A Good Way To Ignore The Market

‘Whenever you find yourself on the side of the majority, it is time to pause and reflect’.

                                 Mark Twain.

 One of the benefits of pound cost averaging is that it encourages investors to ignore the volatility of bull and bear markets and to focus on the investment itself.

3.     A Good Way To Manage Risk

Pound cost averaging is also a good way to manage risk. By investing smaller amounts and often you will become more disciplined as an investor and buy shares at ever lower prices when markets are falling.

4.     Don’t Have A Monthly Cycle

Although this article used the example of monthly instalments, in reality the intelligent investor would invest smaller amounts regularly but only when good investment opportunities present themselves.

Pound cost averaging is a good way for the investor who is just starting out, to begin. It will manage exposure to risk, avoid the development of habits which can be bad for investing and maximise the opportunity to buy shares at good prices. 

Jamie E Smith is the author of Making Money From Stocks And Shares

This content was provided by one of our users, Jamie