The dilemma of when to go into the market is taken away by the discipline of regular savings plans. Putting a small amount of money into a unit or investment trust every month not only adds to the safety but also the efficiency of investing.
The October 1987 crash demonstrated this phenomenon, which is known as pound-cost averaging, as the above graphs show. Both graphs cover a 20- month period from the end of June 1987 to the end of February 1989, over the period of the crash.
The overall investment made in both cases was pounds l,000. Comparing the fortunes of the two, the regular saving strategy worked much better than the lump- sum route.
The regular saver ended up with pounds 1,100 at the end of the period, whereas the lump-sum saver has 16 per cent less with pounds 925. The overall effect of regular saving is to smooth out the short-term fluctuations in the stock market, and to reduce the risk of investing at its peak.
The point about efficiency is dictated by the laws of statistics. A regular saver can actually end up with more units than a lump-sum saver.
When the price of a unit trust falls as the market falls, the fixed monthly payments made by regular savers actually buy more units. And over a period, the average cost of your units will be lower than the average price of the units on those particular dates.
The table below shows this effect on an imaginary unit trust. Over the four-month period, the price of the units fluctuates between 10p and 50p.
A straight average of the figures gives an average price over the period of 27.5p. However, if units were bought at monthly intervals, then at month three, when the price was only 10p, the investor would have been credited with 100 units.
Over the four months, the investor would have bought a total of 200 units, giving an average cost to the regular saver of just 20p.
The beneficial effect of pound- cost averaging is most marked with more volatile funds (our example is extreme to demonstrate the point). It could be most useful as a tool for investing in the riskier types of fund, such as those specialising in emerging markets or other volatile markets such as Japan.
A factsheet on monthly savings and a booklet listing all unit trusts with their minimum monthly savings levels are available free from the Unit Trust Information Service, 65 Kingsway, London WC2B 6TD. Phone 0181- 207 1361 (seven days a week, 8am to 11pm).
q Emma Weiss works for the Association of Unit Trusts and Investment Funds.Reuse content