Pound-cost averaging

HouseBuyer77

Funds which hold things that produce dividends (or more broadly things that produce income, such as bonds) will either pay that out to the holders of the fund or roll the income back into the fund (you will sometimes see one fund available as income or accumulation units so you can choose what you want).

A vanguard life strategy fund will take dividends straight back into the fund, so you will see the combination of income and underlying growth increase the value of your holdings.

EdGasket

bowlhead99 wrote: »

But you think drip feeding would "do better" which is intriguing because the only way that works is if that the money which is not in the investment is consistently getting a better return than the investment.

No, pound cost averaging means you get more shares/units when the price is low so that when the price is 'average' you have more shares/units than you would have done had you simply put the lot in the market at the average price. Maybe if the investment is steadily rising then there is no advantage but if the price is oscillating around a mean like FTSE has been for the last 15 years then I would expect pound-cost averaging to do better overall.

dunstonh

EdGasket wrote: »

No, pound cost averaging means you get more shares/units when the price is low so that when the price is 'average' you have more shares/units than you would have done had you simply put the lot in the market at the average price. Maybe if the investment is steadily rising then there is no advantage but if the price is oscillating around a mean like FTSE has been for the last 15 years then I would expect pound-cost averaging to do better overall.

You are forgetting income. If you are not in it, then you dont get income and that income, if reinvested, buys more units at the lower prices.

You are also forgetting rebalancing. That should occur across the asset classes taking advantage of the ups and downs of the different asset classes.

There is more to life than the FTSE100. Most will be invested in multiple assets and sectors.

Lastly, when drops occur, they tend to be relatively short term. So, your averaging over that short term period doesnt really gain much compared to what you lose by not being invested and earning income.

AndyT678

EdGasket wrote: »

No, pound cost averaging means you get more shares/units when the price is low

Yes - AND it means you get fewer shares/units when the price is high.

Fundamentally if you believe that your investment will grow in value over a long enough time horizon then you should want as much money invested as soon as possible.

However if you don't believe that your investment will grow in value then cost averaging won't help you.

Freecall

I think that you are looking at this the wrong way.

If you decide on an appropriate asset allocation for your needs (whatever that may end up being) then that is what you should have.

Holding chunks of it in cash for a period may smooth purchase prices but it is a form of market-timing, albeit passive.

It is as inevitable that using PCA will reduce your proportionate exposure to your chosen assets. If they are the appropriate ones for your needs then you should buy them asap.

bowlhead99

AndyT678 wrote: »

EdGasket wrote: »

No, pound cost averaging means you get more shares/units when the price is low so that when the price is 'average' you have more shares/units than you would have done had you simply put the lot in the market at the average price.

Yes - AND it means you get fewer shares/units when the price is high.

Giving him the benefit of the doubt, I wonder if he isn't completely forgetting that when pound cost averaging during a period of ups and downs you will often pay a price higher than the price at the beginning of the year, and he does realise this - but he is trying to be clever.

He is thinking of the fact that if price is oscillating around a mean and you buy at all prices, your average purchase price will be the geometric mean price, which must be equal to or lower than the arithmetic mean price, so you appear to be acquiring more units by buying at all prices, than if you had just bought at the arithmetic 'average' price?

But that would be a fallacious argument because you are just looking at the wrong average price.

Consider:
On the first day of three successive quarters, the prices available are 99p and 100p and 101p.

With £3000 to spend, the 'lump sum' buyer will buy at a price picked at random - which if the price is constantly oscillating, as a layman you might expect to be 100p on average. Mr Lump Sum would get 3000 units.

The drip feed buyer would invest £1000 each month and get 1010.101 units followed by 1000 units followed by 990.099 units. Mr Drip Feed buys, in total, 3000.200 units. Which is more than the 3000 units acquired by Mr Lump Sum. It is an extra fifth of a unit. So drip feed must be the winner! Ignoring the fact that share prices generally rise over time and shares pay dividends: if we restrict the exercise to shares that don't pay any more dividends than bank deposit interest would pay, and we only look at a period of static oscillating prices which for some reason are not generally rising over time - we can see that we acquire a greater number of units by drip feeding than if we had bought at the arithmetic average price!

It is of course a fallacious argument. In reality Mr Lump Sum will either buy at 99p and get 3030.303 units, or he'll buy at 100p and get 3000 units, or he'll buy at 101p and only get 2970.297 units. The average number of units he would buy, picking one of those dates haphazardly, must be (3030.303+3000+2970.297)/3 which would be 3000.2 units, even though that geometric mean price of 99.99667p per unit was not a price actually offered.

So, it is completely illogical to say that if prices are bobbling around some level without really going up over time ("market trading sideways for the past 15 years, no growth"), that you "would expect pound-cost averaging to do better". The person sticking a pin in the calendar and buying on that date out of the thousands of business days in the 15 year period, is just as likely to get the 3030.303 units as he is to get the 2970.297 units or the 3000 units.

Pincher

If you were buying shares, the dealing charge skews the result somewhat.


Buy £12,000, and pay £12.90, or
buy £1,000 x 12, and pay £12.90 x 12 = £154.80

0.1% or 1.29%.


If you were drip feeding £100 a month, and paying £12.90 per deal, you would be silly.


With funds, I think you pay an offer to bid spread, so you lose the same percentage whether you buy £100 or £10,000.

Radiantsoul

Lump sum investing will tend to give a better average return, although it will tend to have higher risk.

I think a lot of the talk around pound/dollar averaging is marketing from the people who want you to invest in their products. A lot of people can afford £50 or £100 per month, but don't have a large lump sum readily available to them.

Freecall

Let me try and put it another way. If PCA is so attractive then it should work over any period.

Take a youngster who inherits £100k which he wants to invest for his old age in 40 years time. He can either decide on an appropriate asset allocation and buy investments now or invest £200 a month (or perhaps £2.5k pa to minimise dealing costs) using PCA, keeping the remainder in cash.

This would clearly be daft but conceptually it is no different to spreading purchases out over 2, 5, 12, 60 months or however long the PCA supporters think it works best.

Pincher

It's before my time, but I do wonder what the people who paid The Man from the Pru think it was value for money.

By modern standards, obviously it's a rip off.