How to benefit from falling markets

By STEPHEN MARRIOTT 11/04/2008

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One of the most difficult aspects of investing is judging when the right time to actually invest is. Catching the top or bottom of a market is a rare skill.

That leaves us with a quandary: we want to invest and achieve the best returns for our future but we don’t want to put our hard earned capital at risk just at the wrong time. But how do we improve our chances of entering the market at the right time. One way to achieve this is to spread one’s lump sum into the market as oppose to investing it all in one go. In fact during volatile times this strategy allows one to benefit from what is known as pound cost averaging.

The concept involves saving on a regular basis and most funds are available through regular savings plans allowing an individual to invest on a monthly basis. The beauty of this arrangement is that not only does it instil a sense of discipline to one’s investment habits but also avoids trying to second guess market movements and averages the cost of buying an investment. The other advantage of investing this way is that one never has to remember to utilise their ISA allowance as a savings plan will continue across tax years until the investor stops it. Of course this means that a regular investment of say £100 a month, buys less fund units when markets rise but a higher number will be purchased when shares fall – see the article by our Business Manager for more information on regular savings into ISAs.

It is in falling markets that Pound Cost Averaging really comes into its own. We can see how this works by showing how the current annual ISA allowance of £7,200 would have prospered during the last twelve months to 31 March 2008 (a period of falling markets) by comparing the results of investing it all in one go against investing it on a monthly basis, i.e. £600 per month (at the end of each month). Fidelity Moneybuilder UK Index, a low cost FTSE All Share tracker, is the example fund.

So as we can see investing regularly in volatile and falling markets results in buying more units and at a cheaper price.

Pound Cost Averaging also results in smoother returns as the following chart depicts:

Views are very mixed at the moment. Some commentators feel for example, that the UK market is cheap and is already discounting a slow-down in economic growth, where as some feel that the credit crisis is far from over. However, even the best investors such as Warren Buffet admit that trying to time the market is a mugs game. Therefore at this stage a strategy of pound cost averaging might prove sensible for those who are feeling uncertain about the direction of markets.

Values delayed by at least 15 minutes.
Source: Financial Express