A stock market crash doesn’t come around that often. Bull runs can last for a decade or more, like the one we had from 2009 onwards. But this one was abruptly ended when stock markets around the world entered a bear market this year. The term bear market is used when the main stock market loses over 25% in value over a short period.
For the FTSE 100, this value plunge has been reached and exceeded. The market closed at around 5,000 points yesterday.
What does that mean for the way private investors like us go about investing? Well, during a period when the market is bullish, investors use various strategies to achieve their goals. When we see a bear market, we need to change strategy to suit the new conditions.
That’s why I’m currently using ‘pound cost averaging’ as a strategy in order to boost my long-term potential to profit from current stock market conditions.
What is it?
Pound cost averaging is the idea that by splitting up the amount you want to invest into smaller chunks, you can smooth out volatility in the market and achieve a better overall price. Let’s say I want to buy shares in Company X, with a current share price of 100p. I want to invest £1,000 in total, and so I split this up into 10 amounts of £100. Once a week, I invest £100 into Company X, at whatever the share price is. This week it’s 100p, next week it might be 90p, the week after 95p.
At the end of 10 weeks, I have my full amount invested, but have effectively paid the average price for the shares over the period. This is pound cost averaging.
Why do it?
While this concept is a good idea at any time, it’s especially valid (in my opinion) during a market crash. Using my above example, if I saw the share price drop to 80p and invested everything in one go, I’d have completely committed all of my funds. In a rising market this isn’t too much of a problem, because the probability is that the price will rally. But in a crash situation, the price is falling day after day. This means that using pound cost averaging, I could buy at 80p now, 75p the week after, and so on.
This gives me a much lower blended rate at the end of the period, allowing me to break even and make a profit sooner when the share price starts to rally again.
It also frees me from worrying about trying to pick the absolute share price low. Picking the bottom of the stock market really is almost impossible as I know from experience! To avoid trying to time the market perfectly in the short term, averaging-in step by step reduces the angst. It really is a much more sensible approach to longer-term investing.
So if you have funds you’re looking to invest, I really would suggest using this strategy. It allows you to buy with confidence, even during a falling market like we have now.
