Pound-cost averaging

dunstonh

Pincher wrote: »

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.

Its too easy to knock the old home service agents.

Yes, most of their products by todays standards look expensive. However, you have to remember that they were mostly sold in a higher inflation, more frequent boom/bust period. It was less advanced from a technological point of view and more labour intensive. That said, there are some absolute gems in there which are well worth keeping. They are not all bad.

Another thing to remember is that most financial products need to be sold. The old insurance agents used to get people taking out savings plans and would push pensions and pension top ups. These are not things that most people do off their own back.

in the pension forum, we see it often where someone moans about how useless the pension is and its not paying much. The problem isnt the pension. The problem is the peanuts they paid into it. Often starting with a good premium and having a few years of top ups when the agents called but the agents died off, they never topped up the pension again and inflation ate into that monthly premium and they now pay more on Sky TV than they do their pension.

This is a discussion that has taken place before and is happening again. Is it better to have something that may not be the best rather than having nothing at all?

bowlhead99

dunstonh wrote: »

This is a discussion that has taken place before and is happening again. Is it better to have something that may not be the best rather than having nothing at all?

You could argue that with some 'rip off' fees, the returns on some products were making more for the money manager and their 15000-strong door to door sales team than they were for the customers.

But if the salesman hadn't come round to your house at all, the customers may well have just frittered their money away on whatever vacuum cleaner or fridge or football pools entry was offered by the next salesman.

Better to be getting a paltry £100pm for the next few decades than £100 one-off from ebay for your lava lamp collection that you dug out of the attic.

coastline

link from last year...

http://business.financialpost.com/business-insider/are-you-worried-about-a-stock-market-crash-heres-the-best-way-to-start-investing-right-now

EdGasket

Example: £3000 investment in one go vs 3 lots of £1000 over a period when unit/share price varies from 80p to 120p; average 100p

Investing in one go at the average price over the period results in 3000 units purchased.

Investing in 3 lots of £1000 over the period results in:
£1000 @ 100p = 1000 units
£1000 @ 80p = 1250 units
£1000 @ 120p = 833.3 units

Results in 3083.3 units purchased.

I think this is a fair comparison because the pound-cost averaging bought at the average, the best and worst price over the period but still came out better than investing in one go.

bowlhead99

That response was pre-empted and refuted in post #17.

The example does not work as an example of something that 'came out better'.

Because if the lump sum investor just invested £3000 'in one go' randomly at one of those 3 available prices, he will EITHER get 3750 units or 3000 units or 2499.9 units. He has a 1/3rd chance of getting any of those prices.

The average number of units he will get is (3750 units + 3000 units or 2499.9 units) / 3 , which equals 3083.3.

Conclusion: your fair comparison shows there is no advantage to pound cost averaging. It cannot produce an advantage when it knows nothing about when is the best time to buy.

If you believe in the market you will agree that everything is always fairly priced, nobody can have an advantage, and so it does not matter when you buy - you could buy once in one lump or you could buy a thousand times in a thousand smaller chunks. The difference between the two methods is merely that one is more effective at quickly getting your money deployed into the asset actually want rather than sitting around in cash which you don't want.

If you want to buy a fund because you believe it will give better returns over the long term than sitting around in cash, then you should spend your cash on the fund as soon as the cash is available to you. Then you will invest for longer, reach the long term faster, and achieve your objectives.

Clearly it does not guarantee you will not invest at the top of the market and have to forgo the cheaper prices available later in the year (unless they are still cheap next year when you have more money available) - but all research points to investing sooner rather than later, being more effective than taking a blended average of cash returns and equity returns for the period, in a majority of cases. Because markets grow and pay income.

Personally, I invest on roughly a monthly or at least a quarterly basis and not in crazy big lumps once every year or two, but that is not borne out of a love for 'the power of pound cost averaging'. It is simply because of the restriction that my money comes available each month or two because I earn my money reasonably smoothly over the course of the year and not in crazy big lumps. I spend it on the investments I want as soon as practically possible.

Malthusian

But as others on this thread have said (e.g. Bowlhead), that's not the case. To assume that the lump sum investor would get a price of 100p is cherry-picking. The lump sum investor has an equal chance of buying at 100p or 80p or 120p. On average, the lump sum investor will receive (3000 + 3750 + 2500) / 3 = 3083.3 units, the same as the drip-feed investor. But the lump sum investor will receive more dividends and is more likely to benefit from long-term growth. [edit - Bowlhead beat me to it while I was typing.]

If you read between the lines of Coastline's link, it tells you what pound-cost averaging is good for. It is good if you are a nervous, inexperienced investor who is worried that if they invest £10,000 then tomorrow it might drop to £8,000. Pound cost averaging will mean they don't risk that Day 2 shock.

A more experienced, better researched or better advised investor will know that the risk of their £10,000 falling to £8,000 on Day 2 is totally irrelevant. They are investing for the long-term and they couldn't care less what happens to it on Day 2.

Variations on the word "fear" appear more than once per paragraph on average in Coastline's Business Insider link until it gets to the concept of "pound-cost averaging".

If your two choices are between "drip-feeding" or "investing is scary, I'll keep it in the bank" then drip-feeding is better. But anyone savvy enough to read this board should be able to understand why it doesn't work as an investment strategy. It isn't a means to get better returns, it's a means to overcome fear of risk. Although a better means to overcome fear would be knowledge: to understand that short-term falls in value don't matter (and if they do you shouldn't invest).