Pound cost averaging is investing a fixed sum at regular intervals rather than all at once. Because the same amount buys more units when prices are low and fewer when high, it smooths the average price paid over time.
In one line: Pound cost averaging spreads investing into regular fixed amounts so the average buying price is smoothed across market swings.
How pound cost averaging works
Pound cost averaging is a common approach within pensions and ISAs and is not a regulated product, simply a method of phasing in money. Monthly contributions to a workplace pension are a typical example.
For instance, investing 200 GBP a month buys 4 units at 50 GBP one month and 5 units at 40 GBP the next, so 400 GBP buys 9 units at an average of about 44.44 GBP rather than the higher single-month price.
The approach reduces the risk of investing a lump sum just before a fall, though over long rising markets a single early investment can sometimes outperform.
Pound cost averaging vs lump-sum investing
Pound cost averaging drip-feeds money in and lowers the impact of short-term volatility, trading away some potential return for steadier entry prices.
Lump-sum investing puts all the money to work immediately, which historically tends to win in markets that rise over time but carries more timing risk.
Primary source: FCA: Investing basics