Adrian Corkill, Canada Life International's marketing manager explains how the principles of pound cost averaging can provide opportunities in the downturn.
Uncertain times
Over the past 3 years, fund performance, whether it is UK and Global Equity, Bonds, Gilts or Property has generally returned impressive gains.
However, the recent global credit crisis, coupled with a lack in investor confidence has been reflected in market volatility. This has made investors reluctant to invest in most equity return funds, choosing the safe haven of cash deposits in banks or building societies.
Time, not timing
Experienced investors know that market timing is key to successful investment, but it is also the biggest challenge. They want to invest and achieve high returns but are concerned about making an investment just at the wrong time.
If you choose to invest a single lump sum, you run the risk of investing at the top of the market, which will instantly produce a loss if share prices subsequently drop. Although that works to your advantage if the share prices immediately rise.
So how do you time markets perfectly, especially during volatile times? The answer is that you can trust a fortune cookie or try to improve your chances of entering the market at the right time.
This could be achieved by spreading your lump sum into the market as opposed to investing it all in one go. If you invest regularly, timing becomes far less critical. In fact during volatile times this strategy will allow you to benefit from what is known as “pound cost averaging”.
Pound cost averaging is a term, which describes how an investor can realise a gain during particularly volatile time in the market, by choosing to make regular investments (e.g. using a regular savings plan like the Canada Life International Offshore Savings Account), rather than investing a large lump sum at once.
The principle works on the basis that when the prices are high an investor’s monthly contribution may buy fewer shares or fund units but when prices are low the investment buys more shares or fund units. As a result, the average purchase price paid over by any given period is going to be lower than the arithmetical average of the market price.
Pound cost averaging can reduce investment risk and also takes the worry out of investment decision-making.
A common misconception
If you were to ask your clients: “Which Investment will provide the better return?”, we believe that the majority would answer “Investor A”.
The wise money
In the example above, the correct answer is in fact ‘Investor B’.
Investor A sees the price of his units rise from £5 to £10. He buys 173 units for £1,200 making his average purchase price £6.93 while the arithmetic average for the year is £7.50.
Investor B sees the price of his units initially falling before recovering back to £5 at the end of year. He buys 410 units for £1,200 making his average purchase price £2.92 while the arithmetic average for the year is £5.
At the end of the year investor A has 173 units at £10 (£1,730) while Investor B is in a much better position with 410 units at £5 (£2,050).
Turn bad times into good news with regular saving plans
The good news is that regular saving plans like the Canada Life International Offshore Savings Account `smooth the bumpy investment road`.
By making regular investments of just £250 per month with the Offshore Savings Account investors can forget about the worry of second guessing market movements and reduce the investment risk. According to LifeBase, the offshore product analysis tool for IFAs, the Offshore Savings Account is one of the most competitive regular premium investment bonds available. And not without reason - the Account offers a wide range of benefits such as: an extensive range of funds from leading fund managers, unlimited free switches, no administration fee or restriction on funding and many others.
Adrian Corkill
Marketing & Product Development Manager
Canada Life International Limited. www.canadalifeint.com
