Pound cost averaging...

big_questions

Hello,

So... still doing my homework, reading Tim Hale etc ;-)
Question: I understand the ongoing benefits of pound cost averaging.

But is it relevant to an initial lump sum investment? if I'm investing a say £50k in tracker funds, does it make sense to invest the whole lot at once, or to drip-feed the amount over, say, 1 or 2 yrs? Or is it all much of a muchness?

Biggles

Pound cost averaging is, basically, the opposite of lump sum investment.

There's no good reason to delay the balance of your investment for two years and miss out on the gains. It is, of course, possible that there may be a correction that makes it worthwhile. But, in the meantime, your cash will have lost value anyway.

JohnRo

If you're genuinely investing for the long term then I don't think it's likely to make a huge difference either way. No one knows what the future holds so no one can say which will prove the better option. I think the decision is a personal one based on your own psychology and attitudes to invest risk rather than any convincing technical analysis.

Large lump sum initially will get the full benefit of compounded dividend growth over the investment period but will feel the full effect of valuation movements, for better or worse.

I've used three different types of feeding investments in different accounts at different times but not in any position to draw any meaningful conclusions because there's just too much volatility in the time scales involved and the comparisons aren't like for like anyway.

Personally I think if it's a collective, diversified investment then a lump sum should prove the better option eventually but the added risk is bad timing if an exit is forced on you, which is why it's important to try as much as possible to not invest any money you're ever likely to need for anything other than investing.

big_questions

Thanks JohnRo.
I'll be for a passive portfolio of index trackers.
Sounds like lump sum it is ;-)

JohnRo

I would just say this, if you're the type to be checking valuations every day then a lump sum might prove more emotionally draining than a much smaller monthly feed.

In the early days the lump sum is obviously a much bigger roller coaster with all the effects on your stomach you might expect from such a thing but it's important to keep looking out at the horizon and not the next dip or rise.

atypical

Vanguard's thoughts:
https://pressroom.vanguard.com/nonindexed/7.23.2012_Dollar-cost_Averaging.pdf

"We conclude that if an investor expects such trends to continue, is satisfied with his or her target asset allocation, and is comfortable with the risk/return characteristics of each strategy, the prudent action is investing the lump sum immediately to gain exposure to the markets as soon as possible. But if the investor is primarily concerned with minimizing downside risk and potential feelings of regret (resulting from lump-sum investing immediately before a market downturn), then DCA may be of use. Of course, any emotionally based concerns should be weighed carefully against both (1) the lower expected long-run returns of cash compared with stocks and bonds, and (2) the fact that delaying investment is itself a form of market-timing, something few investors succeed at."

atush

I agree with John Ro, in the end there isn't much of a difference. A LS is better if markets continue to grow, and paying in monthly is better thru periods of volatility/downward markets. No one knows what will happen in future.

I prefer monthly investing using PC averaging for two reasons, as we mainly invest from income not thru Lump sums.

But the one way investing smaller sums is better, is if you might be a nervous investor. One who might sell in a panic if he sees his LS go from 50K to 45K (or even 40K or lower) overnight. Those investors who panic sell don't get their 10% or more back when markets recover, while those who invest money monthly get more shares for their money during those drops.

minimumcost

Look at the performance of the asset class you want to invest in over all the periods you want to invest. E.g. if you want to invest in UK All Shares for a 20 year period look at the performance of every twenty year period the index has existed. (it's here... Google " Incorporating Time into the Efficient Frontier by David M. Blanchett," in Fig 3 and the Appendix at the bottom of the page). If the market is currently above the mean performance put in a lump sum. If it's below drip feed until it's above, then put in the remaining as a lump sum. Thereafter drip feed as you get available funds.

The amount you put in in each 'drip' should be equal to the total you have divided by the number of periods (months) you think you have until you have more money to put in. Thereafter you drip feed as you get more cash.

Archi_Bald

Here's a superb article with lots of links to various views and studies. It's written for dollars, not pounds, but currency doesn't matter in this case. http://canadiancouchpotato.com/2013/05/31/does-dollar-cost-averaging-work/

Their conclusion:

In the end, there’s no right or wrong answer, since the key factors are emotional. Just make sure you understand the trade-off. Investing the lump sum might result in higher blood pressure, but it’s also likely to deliver higher returns.