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The benefits of Investing regularly

Regular investing by putting a set amount each month into a portfolio is a well-recognised approach to building wealth. Not only can it smooth returns, it can also take the hassle out of investing.

Markets rise over time, just not every year

Markets do not rise every year, nor do stocks, even the best ones. This is because in the short term and maybe for extended periods, market levels and performance are not indicative of value. This makes it difficult for investors, who can find themselves oscillating between buying high (‘greed’) and loss aversion, causing them to sell low (‘fear’). In much the same way that diversification is a well-regarded investment approach as it is difficult to know which assets or sectors will be the strongest performers, cost averaging can be used to minimise the risk of buying or selling at the wrong time.

Cost averaging

Cost averaging (CA) is an investment strategy with the goal of reducing the impact of volatility on large investments. By dividing the total amount you are looking to invest into equal amounts, and investing at regular intervals, CA aims to reduce the risk of incurring a substantial loss resulting from investing the entire ‘lump sum’ just before a fall in the market.

The technique is so-called because it has the potential of reducing the average cost of shares bought. CA effectively leads to more shares being purchased when their price is low and fewer when the price is higher. As a result, CA can lower the total average cost per share of the investment, potentially giving the investor a lower overall cost for the shares purchased over time. An example of this in practice can be seen below.

Please note that this strategy does not always guarantee better results, as in a steadily rising market your investment would have benefited more from being made as an initial entire ‘lump sum’.

Drawbacks to this methodical approach

As can be seen in the example below, investors will miss out on the highest returns should the shares continue rising. The cost averaging strategy may trail a lump sum if this was purchased at a lower level. There are a couple more potential factors to consider – the more frequent cost averaging trading could result in a higher level of dealing costs. It’s also important to consider what is being bought, as cost averaging in a poor-quality stock is of little benefit.

An illustrative example of cost averaging

Data supplied for illustrative purposes only

Guide to investing in volatile markets

From the importance of diversifying your portfolio to a five-point investment checklist, this guide highlights what to consider when investing in periods of market volatility.

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Find out more about navigating volatile markets

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