Timing the market? ‘Pound cost averaging’ can make life easy
Written by Martin Upton
Monday 27th February 2017
One overworked cliché about decisions to buy or sell shares and other securities is ‘get your timing right’.
Sound advice. However the history of good investment decisions that were all about good timing, as opposed to simply good luck, is pretty thin.
A few people have become famous for timing the market correctly – George Soros for selling sterling before sterling left the Exchange Rate Mechanism in 1992, and Jon Moulton of Alchemy Partners for selling securities linked to sub-prime mortgages before that market collapsed, but these are individual occurrences for two particular investors and do not reflect general market timing ability. Indeed, retail investors are often sellers in a bear market when prices have already fallen and buyers in a bull market, the exact opposite of ‘buying low and selling high’, which is effectively what a market timing strategy attempts to do.
A way to reduce mistakes of market timing is to invest on a regular basis, such as monthly, quarterly or yearly. This is called pound cost averaging, and reduces the risk of buying at the high and selling at the low. It also reduces the chance of getting market timing right – buying at the low and selling at the high.
If someone invested, for example, £50 a month in a unit trust that invested in shares, then if the market fell they would buy more units and if the market rose they would buy fewer units, since they would be spending an equal amount each month on units that varied in price over time.
It is also worth adopting a similar approach for selling. If someone wants to sell, it makes sense to sell holdings in regular amounts, since it is difficult to tell when the market has reached a peak. Using this technique may be preferable in order to receive a reasonable average return, rather than to hold on, possibly miss the height of the boom, and have to sell when prices have already fallen.
So applying pound cost averaging avoids the need to make guesses about when the market has ‘peaked’ or ‘troughed’ - guesses which, in any case, may be woefully inaccurate.
*Martin Upton is Director of the True Potential Centre for the Public Understanding of Finance (True Potential PUFin)
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