What is pound cost averaging?
"For several years I have read in Moneywise (and other sections of the press) of the benefits of saving regularly into investment trust savings schemes. ‘Pound cost averaging’, whereby more shares are bought when the price is low, is quoted as one of the main benefits. So now, with shares trading at their current level, would seem to be a good opportunity to profit from using this method.
I invest monthly (and reinvest the dividends) in three investment trusts – Glasgow Income, Shires Income and Shires Smaller Companies.
So I was surprised to receive a
letter from Aberdeen Investment Trusts (which administers these trusts) suggesting that, in view of the current downward trend, I
“review my direct debit and/or
dividend reinvestment instructions”.
Surely this is contrary to the idea of pound cost averaging? Shouldn’t savers be taking advantage of the low share prices to buy more?"
Ask the Professionals: Philip Pearson, a partner at P&P Invest in Southampton and an investment portfolio specialist, says:
You’re correct in your assumption about the benefits of pound cost averaging – you average out the peaks and troughs of the share price throughout the year.
This strategy enables you to benefit by buying a greater number of shares when the share price falls, resulting in higher overall investment returns when a recovery takes place.
Aberdeen is probably referring to the high level of volatility experienced within the share price of each trust.
You could interpret Aberdeen’s suggestion to review your direct debit as an invitation to increase your regular monthly saving if you wish to take advantage of the significant discount that currently exists in the share price of each trust.
In my opinion, if you are prepared to invest for the medium to long term, then significant value currently exists, which should boost overall investment returns when share prices recover in due course.
Investment trusts are companies that invest money in other companies and whose shares are listed on the London Stock Exchange. As with unit trusts, private investors buying shares in an investment trust are buying into a diversified portfolio of assets (to reduce risk), which is managed by a professional fund manager. Investment trusts differ from unit trusts in two important ways: they are listed on the stockmarket and so are owned by their shareholders and are closed-ended funds with a finite number of shares in issue. This means the share price of investment trusts might not reflect the true value of the assets in the company (known as the net asset value, or NAV) and if the NAV value of a share is £1 and the share price in the market is 90p, the trust is said to be running a discount of 10% to NAV. But this means the investor is paying 90p to gain exposure to £1 of assets. Investment trusts can also borrow money and use this money to buy investments. This is known as gearing and a geared trust is thought to be more of an investment risk than an ungeared one.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.