The Pros and Cons of ‘Pound Cost Averaging’
ISAs represent a tax-efficient vehicle for savings because any interest gained on them does not attract tax. At Taxfile, particularly in respect of Stocks & Shares ISAs, we’re often asked whether a lump sum investment is better or worse than a regular ‘drip-feed’ of smaller payments. If the two total the same amount over the course of a year, which is the best method of paying into an ISA?
Well, it all comes down to market conditions, timing and ‘Pound Cost Averaging’. A regular drip-feeding of smaller investments can take the worry out of investment decision-making because it reduces exposure when markets are falling and also it results in a smoother, less volatile, ride. If a larger lump sum were invested and the market fell, it could clearly be a disaster. Compared to that, regular, smaller payments would mean that only a small amount was invested while the market was at its lowest – and even then it would have purchased comparatively more shares because they were then much cheaper (an opportunity which would have been missed with the earlier one-off lump sum approach). Similarly, with a regular drip-feed of smaller payments, fewer shares are purchased when they are at their most expensive.
So … in an uncertain, falling market the cost of the shares usually works out cheaper over the course of the time period in question when utilising a regular drip-feed approach. In those conditions you usually end up with more shares for the same money — this is what is known as Pound Cost Averaging. However it should be noted that in a rising market the lump sum investment would usually win. So the proverbial crystal ball would certainly come in handy but in lieu of that the regular payments of smaller amounts can help to both hedge bets when things are uncertain and instil a sense of investment discipline, also removing the need to try to predict what the markets are going to do.
At Taxfile we’re here to help with your tax affairs and can let you know the ISA investment allowances for any given year so that you can make the most of your tax allowances – just contact us and we’ll be happy to help.
The information above does not constitute financial advice. Always do your own research to ensure investments are right for your own specific circumstances.