One of the ways savvy investors get ahead of most of the market is by using a little/known trick that the American’s call ‘dollar cost averaging.’
In the UK this should be called ‘pound cost averaging’ but the principal - and the mathematically undeniable benefit - is the same.
Here’s and example of how it works, using the FTSE 250 Index of the UK’s leading 250 is public companies.
Over the last two years the price of a share in this index went up from £17,042.96 to a high of £23480.81 before dropping back to a May 2022 value of £20417.95.
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Whether you are investing £1,000,000 in shares across the index or £10,000 in an investment fund that tracks this index, the principal is the same and the gain you can make in percentage terms is the same.
By waiting to the end of each financial year - or calendar year - to invest money you save, you end up owning less stock for the same spend compared to someone who purchased stock or fund units every month.
Then when the shares rise in value, this difference magnifies. Here is a worked example, using the actual FTSE 250 share price, and investing £1,000 per month in a fund where where the value of each unit is 10% of the share price:
| Date | FTSE 250 Price | Unit Price | Units |
|---|---|---|---|
| May, 2022 | 20,417.95 | 2,041.80 | 4.90 |
| Apr, 2022 | 20,708.71 | 2,070.87 | 4.83 |
| Mar, 2022 | 21,160.07 | 2,116.01 | 4.73 |
| Feb, 2022 | 21,081.05 | 2,108.11 | 4.74 |
| Jan, 2022 | 21,926.62 | 2,192.66 | 4.56 |
| Dec, 2021 | 23,480.81 | 2,348.08 | 4.26 |
| Nov, 2021 | 22,519.72 | 2,251.97 | 4.44 |
| Oct, 2021 | 23,106.61 | 2,310.66 | 4.33 |
| Sep, 2021 | 23,031.29 | 2,303.13 | 4.34 |
| Aug, 2021 | 24,102.19 | 2,410.22 | 4.15 |
| Jul, 2021 | 22,948.83 | 2,294.88 | 4.36 |
| Jun, 2021 | 22,376.02 | 2,237.60 | 4.47 |
| May, 2021 | 22,683.95 | 2,268.40 | 4.41 |
| Apr, 2021 | 22,497.37 | 2,249.74 | 4.44 |
| Mar, 2021 | 21,518.71 | 2,151.87 | 4.65 |
| Feb, 2021 | 20,910.37 | 2,091.04 | 4.78 |
| Jan, 2021 | 20,228.58 | 2,022.86 | 4.94 |
| Dec, 2020 | 20,488.30 | 2,048.83 | 4.88 |
| Nov, 2020 | 19,336.32 | 1,933.63 | 5.17 |
| Oct, 2020 | 17,214.38 | 1,721.44 | 5.81 |
| Sep, 2020 | 17,315.30 | 1,731.53 | 5.78 |
| Aug, 2020 | 17,788.33 | 1,778.83 | 5.62 |
| Jul, 2020 | 16,932.65 | 1,693.27 | 5.91 |
| Jun, 2020 | 17,119.16 | 1,711.92 | 5.84 |
| May, 2020 | 17,042.96 | 1,704.30 | 5.87 |
| TOTAL UNITS | 122.20 |
The investor who pays into their ISA, pension or trading account monthly pays an average price per pound (or dollar) for their units or shares and accrues 122 units in the fund, which is a gain of 10 units, compared to investing in April/May each year (start of the financial year).
The monthly investor gains by buying stock more in cheap months, then that stock rises in value each month from then, and the investor continues to add more stock.
As you will see in the conclusion, this adds up to significant financial gain very quickly.
But what about in a market decline?
If an investor can time the market so that they buy at the one lowest point in a year, then they may do better than pound cost averaging.
But without a crystal ball, how can you know that you have picked the bottom of the market?
It's more likely that you miss it, and therefore miss out on the several cheap months of decline.
In our example, if you look just at 2021, the market is in a temporary decline.
Only by investing 12 months of savings in the month of May, can the annual investor match the monthly investor. They cannot beat them, no matter which month they pick.
Conclusion
Overall, in this example the investor who invests monthly for two years, gains £21,000 more than someone who invests once a year.
This difference, which is effectively free market gains, continues to compound thereafter.
