The Latest News From The Motley Fool: Dance with the bears

The Motley Fool started as an irreverent investment newsletter and has grown to become one of the most popular personal finance and investment websites. Anyone who follows its philosophy is called a 'Foolish investor'.

This week, let's switch off the markets for a while, forget about how our favourite companies are faring, and have a look at some good old Foolish basics.

Most people who start investing do not have large lump sums available, and need to fund their investments from regular monthly savings instead. One way of doing this, and one which is greatly favoured in Foolish circles, is by the use of an index-tracker fund.

An index-tracker is a fund which simply spreads its money across the whole of the index in question, the FT-SE 100 for example, and gives a long-term return very close to the actual index itself. By simply doing this, index-trackers beat about 90 per cent of all actively managed funds. But tracker funds themselves are not the subject for today.

Today we are going to talk about pound-cost averaging.

If you have just started your regular contributions to your tracker fund, how do you think you are going to feel if the FT-SE 100 starts falling? If you are Foolish, and are investing for the long term, you should not feel bad at all.

Warren Buffett, probably the world's best-ever investor, likes to compare the long-term buying of shares with hamburgers. If you plan to be buying hamburgers every week for the next 30 years, which way should you want the prices to move over the coming weeks and months?

That's an easy one: you would never actually want the price of hamburgers to rise again, no matter how long you wait. But you do want your shares to have grown in value by the time you come to retire and buy your yacht.

However, falling values make pretty good sense in the shorter term. If you are a net buyer of shares, and you won't want to be selling any for at least a couple of decades, shouldn't you want the prices to fall so that you can get more for your money next month?

Suppose a company's shares are selling for pounds 10, and you invest pounds 100 one month, getting you 10 shares. Then there is a market crash and the price falls 50 per cent to pounds 5. Next month, you invest your next pounds 100, and this time you get 20 shares for the same money. You now have 30 shares, where you would only have had 20 if the price hadn't fallen. And what was your average purchase price for your shares? You need to divide the total price paid for all your shares by the number of shares you have bought. That's pounds 200 divided by 30, for an average price of pounds 6.67.

Now, by the time your next month's investment comes around, our favourite share price is back to pounds 10 again. This time, you get your 10 shares, giving you a total of 40, and costing pounds 300. Your average share price is now pounds 7.50 and the shares are worth pounds 10.

Congratulations, you are sitting on a profit of pounds 2.50 per share and that is an effect known as pound-cost averaging. Your pounds 300 has turned into pounds 400.

Okay, so markets don't often crash 50 per cent and recover the next month, but when they're down, you get better bargains. Over the decades that Foolish investors are interested in, markets rise, no matter what short-term fluctuations there are in the meantime.

The inescapable conclusion for Foolish investors who believe that stock markets will rise over the long term is that we should invest our money regularly on a steady pound-cost basis. Short-term falls will increase our eventual long-term profits, not decrease them.

n Motley Fool: www.fool.co.uk

Start your day with The Independent, sign up for daily news emails
News
ebookA unique anthology of reporting and analysis of a crucial period of history
News
people
News
Richard Blair is concerned the trenches are falling into disrepair
newsGeorge Orwell's son wants to save war site that inspired book
Life and Style
Audrey Hepburn with Hubert De Givenchy, whose well-cut black tuxedo is a 'timeless look'
fashionIt may be a paradox, but the industry loves it
Arts and Entertainment
The pair in their heyday in 1967
music
Life and Style
fashionFrom bathing dresses in the twenties to modern bikinis
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Guru Careers: Software Developer / C# Developer

£40-50K: Guru Careers: We are seeking an experienced Software / C# Developer w...

Neil Pavier: Management Accountant

£45,000 - £55,000: Neil Pavier: Are you looking for your next opportunity for ...

Sheridan Maine: Commercial Accountant

£45,000 - £55,000: Sheridan Maine: Are you a newly qualified ACA/ACCA/ACMA qua...

Laura Norton: Project Accountant

£50,000 - £60,000: Laura Norton: Are you looking for an opportunity within a w...

Day In a Page

Abuse - and the hell that came afterwards

Abuse - and the hell that follows

James Rhodes on the extraordinary legal battle to publish his memoir
Why we need a 'tranquility map' of England, according to campaigners

It's oh so quiet!

The case for a 'tranquility map' of England
'Timeless fashion': It may be a paradox, but the industry loves it

'Timeless fashion'

It may be a paradox, but the industry loves it
If the West needs a bridge to the 'moderates' inside Isis, maybe we could have done with Osama bin Laden staying alive after all

Could have done with Osama bin Laden staying alive?

Robert Fisk on the Fountainheads of World Evil in 2011 - and 2015
New exhibition celebrates the evolution of swimwear

Evolution of swimwear

From bathing dresses in the twenties to modern bikinis
Sun, sex and an anthropological study: One British academic's summer of hell in Magaluf

Sun, sex and an anthropological study

One academic’s summer of hell in Magaluf
From Shakespeare to Rising Damp... to Vicious

Frances de la Tour's 50-year triumph

'Rising Damp' brought De la Tour such recognition that she could be forgiven if she'd never been able to move on. But at 70, she continues to flourish - and to beguile
'That Whitsun, I was late getting away...'

Ian McMillan on the Whitsun Weddings

This weekend is Whitsun, and while the festival may no longer resonate, Larkin's best-loved poem, lives on - along with the train journey at the heart of it
Kathryn Williams explores the works and influences of Sylvia Plath in a new light

Songs from the bell jar

Kathryn Williams explores the works and influences of Sylvia Plath
How one man's day in high heels showed him that Cannes must change its 'no flats' policy

One man's day in high heels

...showed him that Cannes must change its 'flats' policy
Is a quiet crusade to reform executive pay bearing fruit?

Is a quiet crusade to reform executive pay bearing fruit?

Dominic Rossi of Fidelity says his pressure on business to control rewards is working. But why aren’t other fund managers helping?
The King David Hotel gives precious work to Palestinians - unless peace talks are on

King David Hotel: Palestinians not included

The King David is special to Jerusalem. Nick Kochan checked in and discovered it has some special arrangements, too
More people moving from Australia to New Zealand than in the other direction for first time in 24 years

End of the Aussie brain drain

More people moving from Australia to New Zealand than in the other direction for first time in 24 years
Meditation is touted as a cure for mental instability but can it actually be bad for you?

Can meditation be bad for you?

Researching a mass murder, Dr Miguel Farias discovered that, far from bringing inner peace, meditation can leave devotees in pieces
Eurovision 2015: Australians will be cheering on their first-ever entrant this Saturday

Australia's first-ever Eurovision entrant

Australia, a nation of kitsch-worshippers, has always loved the Eurovision Song Contest. Maggie Alderson says it'll fit in fine