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Understanding investing for beginners
Investing a large sum of money in the stock market at any one point carries risk for the investor. If prices suddenly fall, there will be an immediate reduction in portfolio value, which can cause anxiety. Some investors might want to wait to feel more comfortable in the market before investing, but that time might never arise, so they could exist in a state of paralysis.
Hesitancy in these situations is understandable, particularly for first time investors, who sometimes have to learn the art of shutting out speculation and noise, and relying on market forces.
If you’re reading this and thinking that it sounds like you, you might be interested in the concept of pound cost averaging.
The concept is basically that instead of investing a lump at once, you drip feed money in regularly to buy your stocks at different price points, therefore “averaging” the price you buy them at.
How investing works
In this hypothetical scenario, an investor with £20,000 might want to spread investments over a 10- month period, investing £2,000 at a time.
In the first month, the stock price is 100p, so the investor buys 2,000 units valued at £1 each. Next month, the value has dipped to 90p, so the investor is able to buy 2,222 units at 90p. The next month, the stock rebounds and is valued at 110p, which means the stock bought in the second month has increased in value by 22% and stock bought in the first month has increased by 10%. The downside being that this month’s purchase is valued at 110p per unit, so this stock will never be as valuable as the previous month’s purchase.
This is a defensive strategy that allows for investors to diversify the value of their holdings. If the investor had put the entire £20,000 in at any single point over those three months, the value would be very different.
It’s impossible to time the market, and although we believe in the overall efficiency of markets to generate a return based on investing at almost any point (the overall trend of markets, historically, has been upwards), this strategy can offer a bit more comfort.
People who pay into a workplace pension usually benefit from pound cost averaging. If you’re paid regularly, your investments will be made regularly in the funds that your pension provider invests in, so you will have bought your retirement funds at various price points. This will protect you against drops in fund value and ensure that you’re “buying the dip” without even knowing it.
The value of an investment can go down as well as up, you may get back less than you originally invested. Past performance is not a guide to future performance.