Risk and reward

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7. Pound cost averaging - a way round risk

Pound cost averaging is a simple concept, and not everybody agrees with it, but it is worth taking on board, if only because it has an interesting theoretical underpinning:

• If you buy £5,000 of shares in a company on January 1st, you may be getting those shares cheaply or you may be getting them expensively, depending on whether the price of the shares is higher or lower on February 1st.
• If you buy £500 of shares in the company every month for 10 months, regardless of what happens to the share price in that period, you will automatically average out your cost of acquisition. Some shares will be bought too expensively, others very cheaply, but because your monthly allocation is based on an amount spent (£500) not on a number of shares, you will always be buying more of them when they are cheap.

Of course, every transaction costs money in brokers' commissions and Stamp Duty, so periodic small purchases are inefficient. But if you adopt pound cost averaging through a savings scheme (with an investment trust for instance) these costs come right down.

Critics of pound cost averaging argue that if you have a lump sum to invest, it is better to invest it all at once rather than piecemeal over several years. The reason is that markets tend to rise over time, so it makes no sense to leave money out of the market.

Summary: pound cost averaging is a way of avoiding both specific risk and market risk, but is best suited to those who do not have a lump sum but do have regular savings which they can drip feed into the market.

1. The right place for your spare money? 2. The golden rule 3. Stock market performance and inflation 4. Stock market performance compared to savings accounts 5. Specific risk 6. Market risk 7. Pound cost averaging - a way round risk 8. Overseas investments - currency risks 9. Conclusion

• Against the Gods