Pound Cost Averaging: Why investors and investment houses should learn from runners.

 

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Make the most of the downhills in your investment strategy (Alexis Martín, Flickr)

 

Analogies can be hit and miss, but that doesn’t stop me from deploying them almost constantly in conversation. Because running is such a significant part of my life, there has been a tendency to see much of the work I do through the lens of physical activity and effort proves to be highly relatable in many service journeys.

Thanks to my one-time boss and good friend Darren, I was engaged in a conversation on Facebook recently pertaining to investments. With an undulating landscape of financial predictions, the chat was about how your unsophisticated public investor might make the right decisions about how much to invest and when.

Darren highlighted the strategy of Pound Cost Averaging, something I wasn’t aware of and which can be described thusly

The basic idea behind pound-cost averaging is straightforward; the term simply refers to investing money in equal amounts at regular intervals. One way to do this is with a lump sum that you’d prefer to invest gradually–for example, by taking £1,000 and investing £100 each month for 10 months. Or you can pound-cost average on an open-ended basis by investing, say, £100 out of your paycheque every month. The latter is the most common method; in fact, if you have a defined contribution pension plan, you’ve probably already been pound-cost averaging in this way.

Source: Morningstar

Now, that’s one way of essentially distributing an investment over time to spread the risk, prevent you getting carried away trying to read the market but keeping you ‘in the zone’ of investing when you might not feel like it.


Aside
There’s good evidence that it’s a very sensible strategy, albeit one that is not at the aggressive end of possible returns. Writing with refreshing candour in  The Spectator in November 2015 Louise Cooper highlighted how such a simple approach is a solid antidote to the lack of expertise that Fund Managers really have.


 

Now, what I’d like to see – and what interested me about Darren’s comments – was the potential to flex these regular contributions in line with the market’s movements. This is where the analogy really begins.

As a long-distance runner, the absolute best thing you can learn in an event like the marathon is pacing. You want to distribute the effort across the race and there’s some really good literature to support it. No course is completely flat and this means you have to modify the effort to match the gradient, you ease off a bit on the uphill and, within reason, make some benefit on the downhills. Using Heart Rate as a guide you might aim for a consistent effort of 165 BPM, keeping that constant on hills means dropping pace, on the downhills your heart is under less load so you can speed up a bit. Recently the website Flying Runner allowed you to create a minute-per-mile pace band that reflected the slight modifications you’d make throughout the race depending on the gradient or effort required.

Now consider investing, let’s say you want to invest £10,000 this year. You can trickle that out evenly across the year in £833.33 increments, assuming a flat market. But what if you wanted to follow the FTSE and say invest a little more when the market is on a downturn and invest a little less when it’s climbing? Doing so would make the most of the market movement but keep you within a framework that spreads the load.

There are issues with this approach of course: a period of consistent decline might over-stretch a finite investment pot, so if I put £850 in for the first 4 months of the year then I’ve used up more of my £10,000 but with no guarantee that I’ll make it up if the market doesn’t subsequently ascend. That’s a crucial difference. In the marathon, we know the profile and the distance of the course in advance and can plan how much to scrub off or add on to our pace with the gradients and the total distance predetermined. That said, this is a longer play than a marathon and a decade of investing this way is sure to see the amounts even out. The problem then becomes setting a monthly amount that you can afford: For example setting hard maximum investment and a hard minimum that is reviewed each year according to salary changes.

The second issue is fees and logistics. The sad truth is that nobody appears to be setup to allow the public to effortlessly invest in this manner. Often each investment incurs a commission thereby wiping out the gains if you’re making 12 of them per year. Additionally, no provider appears to offer automatic modifications that track the market gradient against your personal tolerances [happy to be corrected], although Share Centre certainly support a savvy customer doing it themselves. Evidently, there’s nothing to stop one doing it oneself with a spreadsheet and a diligent approach to calling in or going online to tweak the figures. Does this constitute a direct example of where Big Finance is theoretically working against customer behaviour by penalising us through regulatory-inflicted charges? Is it an example of an opportunity that could be exploited by FinTech, able to quickly build a front-end to an investment vehicle that is aligned to plausible customer behaviour? Well, until I can find a service to meet my desired approach I’ll just have to work on my own Google Spreadsheet and work towards the release of the first endurance-inspired investment strategy.  Given that the Brexit marathon starting pistol has just been fired, perhaps now is the time to, caveat emptor, give it a go?

 

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