Pound cost averaging: An update

Back in June 2016 I wrote about how investors might learn from the endurance runner who modifies their effort according to the terrain. Since then I have been looking at what sort of numbers a strategy like this might have returned in 2016.

To recap, assume I decide to invest around £1200 a year. I decide that I’m going to average this at £100 per month, but if the market is falling I will invest more (to take advantage of lower prices) and if the market is rising I will invest less (because my money will buy less stock).

I took the FTSE100 index as a guide, establishing the index position on the first of each month (or as close to as possible). I determined the rise or fall in the preceding month. For example, on 1st Jan 2016 the index was 6903.4, on 1st Feb it was 6060.1, just 87.78% of the value. This meant I would invest £112.22 in February. I called this my ‘Modified PCA’ (Pound Cost Average). In February my £112.22 bought theoretical ‘shares’ which were tied to the FTSE100 index, so £6.06 per unit, giving me 18.52 units. I followed this pattern for the entire year and benchmarked it against a strategy which simply bought £100 worth of shares each month. As a control, I also looked at performance against a scenario where I had invested £1200 in one lump sum at the FTSE100 ‘share price’ in January (£6.90).

By the end of the year there had been only four months where the market fell from the previous month. My total expenditure on the Modified PCA was £1201.08 (assuming I didn’t add another amount in January 2017). I was surprised it was so close to the strict average. The effect of adjusting my effort meant that the value of the ‘shares’ I owned was now £1419.47, a healthy 9.63% return. By contrast, a strict normal PCA of £100 a month investment would have left me with £1423.45, a little more in absolute terms but the reduced buying power in a rising market meant a slightly lower return, 9.5%. Nevertheless, if I had just invested all £1200 in January 2016 I’d have made only £48.69, just 4.05%.

Of course, this is just based on my basic maths (easily my weakest subject) and assumes investing in the FTSE100 as a simple index rather than a specific fund, but it just shows that there is some real-world opportunity in taking a consistent and disciplined approach to monthly investment. Now if only I could apply that to my sub 3hr marathon project…

Raw data here (please do interrogate and correct me if wrong)

 

Coda
A Morningstar piece identifies that plain old PCA is only better than lump sum investing during falling markets. It’s a good summary of the potential but I still haven’t seen anyone using a modified PCA like mine and it and this Money Observer piece also make it clear, again, that regular investing penalises the investor with transactional fees.

Finally, my approach also falls into the Black Swan trap of using historic data to inform future investment decisions.

 

 

 

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