How To Make The Most Of Market Volatility

Jane Baker takes a look at the advantages of investing regularly.

Sometimes it can take nerves of steel to brave the stock market, particularly when prices are falling. The temptation to cut your losses can be hard to resist even if that means losing money. But there is a way to invest which could mean fluctuations in the market need not be quite so alarming. Attempting to time the market is tough since, without the aid of a crystal ball, there's no way of telling where the market might head next. 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 tumble. Although that works to your advantage if the market immediately rises, if you invest regularly instead, timing becomes far less crucial. What's more, by drip-feeding your investment you can actually do well out of market volatility using what's known as 'pound cost averaging'. Pound cost averaging may sound like a complex term but it's a pretty simple concept which allows you enjoy upturns in the market while cushioning your investment from any downturn. If you invest a constant amount every month each investment will purchase shares (or units if you are investing in a unit trust) at a different price as the market fluctuates. This means when the price rises you'll buy fewer shares, while in a falling market you'll simply acquire more shares for the same amount. OK, that might sound like a rather obvious statement but it's worth knowing that by phasing your investment, the average purchase price you will have paid over any given period will always be lower than the average market price. And this applies regardless of whether you're investing in a rising or falling market as the tables below demonstrate: In A Rising Market Regular Investment Each Month Share Price Number Of Shares Purchased £100 £20 5 £100 £25 4 £100 £50 2 In this example, the average purchase price paid by you is £27.27 (£300 divided by 11) while the average market share price is £31.67 (£95 divided by 3). This means pound cost averaging has saved you around 16% off the average market price. And this is exactly the same situation when prices reverse: In A Falling Market Regular Investment Each Month Share Price Number Of Shares Purchased £100 £25 4 £100 £20 5 £100 £10 10 This time the average purchase price paid by you is £15.79 (£300 divided by 19) while the average market share price is still around 16% higher at £18.33 (£55 divided by 3). Source: Newton Investment Management Ltd. Even as prices fluctuates continuously in both directions, the principle of pound cost averaging still works whether you're investing directly in shares, in a tracker or managed fund, or a share-based pension. Indeed, I pay a regular monthly amount into my pension plan and I like the fact that I can leave to it to work its magic without having to keep an eye on the unit price. Regular investing certainly offers some protection from market volatility as your contributions are exposed to a range of prices over time. But don't think that means it will automatically be a more successful strategy than investing a single lump sum. Pound cost averaging doesn't always beat lump sum investing but it does mean that timing becomes irrelevant. It can also be an effective approach if you're bold enough to invest during a bear market when prices are generally falling across the board for a prolonged period. Here you can build up an investment without even having to consider when the market might bottom out. Instead you'll have the opportunity to purchase plenty of shares when prices are low which are poised to take-off when the market recovers. On the other hand, if you're investing in a rising market when prices are on the up you may lose out on some growth potential if you compare that with the investor who was lucky enough to invest a single sum at the bottom of the market. But even so, I think the benefits of pound cost averaging in managing market volatility compensate for that risk. It's entirely understandable that you may want to sell up if the market collapses. Indeed, many of us are only tempted back once a recovery has clearly begun. But regular investing should give you the confidence to stick with it however erratic the market may be. If investing regularly appeals to you, it can easily be done using Motley Fool Sharebuilder. This costs just £1.50 per purchase, and you can start or stop trading whenever you want. Even better, until 31 December 2007 all ShareBuilder purchases are absolutely commission-free! With low expenses you can drip feed your money into the market from as little as £20 per month. So go on, open a Motley Fool share dealing account today!