Pound-cost averaging and lump sum investing are two different investment strategies, and either could be the tonic for your stock market timing stresses.
In short, pound-cost averaging involves regular and consistent contributions, while lump sum investing is the exact opposite, as it sees you invest a large chunk of money all at once.
But let’s examine the nuances of the two, find out more about how and when they might work, and ultimately help you to decide when to invest a lump sum and when to drip-feed into investments.
Pound-cost averaging, synonymous with dollar-cost averaging, is a regular investing strategy investors often use to smooth out the ups and downs of the market.
It involves investing the same, or roughly the same, amount of money at regular intervals. This will result in the purchase of more individual units of an asset when prices are low and fewer units when prices are high.
The goal is to end up with an average purchase price which should look a lot smoother throughout the life of the investment.
Theory is great, but let's look at how pound-cost averaging works in practice. In basic terms, you need to:
You can even use recurring orders to automate this process.
So, let’s look at an example which can showcase the potential benefits of pound-cost averaging.
The same 245 shares would have cost £2,450 at the time of the first investment. In this example, drip feeding money into the market at monthly intervals resulted in a lower cost than a single lump sum investment.
But this is not always the case. Things could have gone the other way.
If the shares had instead climbed on a consistent basis over the year, you may have been better off buying them all at once initially.
While pound-cost investing smooths out any declines in the market value of an investment, it also smooths out any big gains, meaning you may not generate as big a return had you invested a lump sum upfront.
And there could have been a dividend on offer at some stage during the year, which would have benefited from an initial lump sum investment too.
The key here is that we just don't know how the market or a specific stock will look in a given period of time. So, as we've said, there's a psychological benefit to investing regularly and knowing all of your money isn't exposed to any potential drops.
In short, pound-cost averaging is about:
Unlike pound cost averaging, lump sum investing puts your money to work straight away. Given we know the time you give your money to grow is an incredibly important aspect of long-term investing, putting that lump sum into the market right away rather than spacing out regular investments certainly can have some benefits.
Lump sum investing can make sense where an investment platform has high trading fees, too. If you have to pay £10 every time you buy a stock, investment trust or exchange-traded fund (ETF), that would already set you back £120 a year on a monthly investing plan. So, it's probably more reasonable for investors to save up two or three months' worth of earmarked money and invest that less frequently.
It would be disappointing to let the platform dictate your strategy, though, especially if it leads to an erratic investment schedule just because of pricing outside your control.
That's much less of a consideration when those trading costs are low or the platform is commission-free.
There's a behavioural niggle that can crop up if you're storing up a few months' worth of cash as well, and that's the urge to want to time the market. We’ve seen how difficult that can be!
Whether you're sitting with a lump sum from an inheritance, a bonus, or just general under-the-bed savings that you'd like to invest, there is always the temptation to hold off for a slightly better price tomorrow.
This concern about timing the market might have you stuck between investing a lump sum, using pound-cost averaging, or some other technique.
Let’s look at an example of five different investor attitudes to see how timing can lead to different outcomes.
In this example, based on research from the Schwab Center for Financial Research, five investor archetypes received $2,000 at the beginning of every year from 2001 to 2020.
So, who fared best?
A few key takeaways here, with the obligatory reminder that none of this dictates what might happen in the future in terms of investment returns.
Perfect timing won, but expecting to pick the exact right moment to invest is, to put it mildly, a little unrealistic. A timing obsessive could just as easily have been the bad timer, or even the side line waiter.
We need to go back to what we said at the start. The maths might tell us which approach gave the best returns, but there is just no accounting for real circumstances.
If we discount our ability to time the market perfectly, in the end, having your money in the market is the most important thing.
The immediate investor has the edge over our monthly saver simply because they have given their money more time to accumulate dividends and build up that snowball effect of compounding.
Again, though, most of us think about investing in terms of monthly expenditure. In that sense, setting up a monthly savings plan for your investments would have been simple and efficient over these 20 years.
Advantages:
Disadvantages:
Advantages:
Disadvantages:
According to research from Northwestern Mutual, lump sum investing beats pound-cost averaging around 75% of the time. But, by now, hopefully it's clear that we have to factor in our personal and wider circumstances here too.
Investing regularly in a set of assets takes the decision-making out of it all. It's also a great habit to stop you fiddling, getting stuck in the headlights or trying to time the perfect entry point.
It can be a particularly valuable way to invest during a bear market. There's no telling when the market will snap out of its bad mood, so edging into the market regularly means you don't have to rely on your crystal ball.
You might have a string of lower prices, but at least you aren't pinned to the first (and highest) price. What's more, as the market starts to rise, you'll break even quicker as you've been able to steadily reduce your average price.
Meanwhile, lump sum investing can also take the worry out of your decision-making and allows you to maximise your time in the market. Though research indicates lump sum investing is more likely to offer high returns, you could also find yourself at the mercy of market fluctuations and even experiencing buyer’s remorse if things go south quickly.
Remember: You do not have to pick one strategy or the other; you could do both! If you get a bonus, you might decide to invest it as a lump sum, while you could decide your salary is better invested using pound-cost averaging. Find a scenario that works for you and your circumstances.
Whatever you decide, you can open an account with Freetrade and begin investing now!
While pound-cost averaging might not always be the right strategy for you, we have noted that one of the major advantages of the strategy is that it can help you to form good habits, such as regular investing. If you've decided regular investments are for you, automating it just means one less thing to think about.
Setting up automatic recurring orders means you can leave the emotion at the door and let the process do the work for you. Here’s an example of how a regular investing habit can reward you over the long term.
Opening our maths books again, here's an example of how an ISA investor could reach that £1,000,000 investment portfolio. It's not a cast-iron route to seven figures by any means, and even if it's not your goal of investing, but it serves as an illustration of what a steady, long-term investment plan could deliver.
Putting your cash to work over the long term makes the most of the magic of compounding. Source: Freetrade, 2022.
Yes, pound-cost averaging and dollar-cost averaging are the same investment strategy. The only difference is in currency, as the former uses pounds and the latter uses dollars. Investors using the strategy in the Eurozone might likewise refer to it as Euro cost averaging.
Warren Buffett does not rely on dollar-cost averaging, with his approach instead tending to be characterised as that of a value investor. In short, this means he sniffs out undervalued companies with the potential to generate strong long-term earnings. However, Buffett has in the past recommended it for most retail investors.
"If you like spending six to eight hours per week working on investments, do it. If you don't, then dollar-cost average into index funds."
Investing even a relatively small amount of money each month can lead to surprisingly large returns over time. This is thanks to the steady stream of cash you are putting into your investments and the effects of compounding.
Even without any growth, you would have £12,000 set aside after two decades. Growth can lead to even stronger returns from your seemingly low levels of investing.
Find more useful information about compounding in our guide to investing in stocks.
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General investment account
Stocks and shares ISA
Commission-free investing in 6,500+ UK, US, and European stocks, ETFs, and more
FX fee of 0.59% on non-GBP trades
3% AER on up to £2k uninvested cash
General investment account
Stocks and shares ISA
Personal pension (SIPP)
Commission-free investing in 6,500+ UK, US, and European stocks, ETFs, and more
FX fee of 0.39% on non-GBP trades
5% AER on up to £3k uninvested cash