While the FTSE 100 may have experienced a pullback in recent weeks, its long term potential remains high. Evidence of this can be seen in its track record, with it averaging a return of 7%+ in the long run.
Of course, many investors may wish to try and time the market in order to beat its average return. But for many time-poor investors, dripping a relatively small sum into the UK’s main index each month could be a smart move for the long run.
Cost averaging
While all investors would love to buy shares when they trade at their lowest point and sell at their highest price, this is exceptionally difficult to achieve in the long run. Stock markets are inherently volatile and tough to predict in the short run. This means that buying a smaller number of shares more frequently could help to maximise total returns, longer-term. It could allow an investor to access shares when they are trading at a range of prices over time. This would reduce their average cost and mean that the total profit on offer could be relatively high.
Higher highs
One reason why buying shares often in small amounts could work is that stock markets have always reached higher highs. In other words, while they may experience difficult periods and experience downturns, in the long run they have always recovered to reach new records. As such, an investor who buys shares in the index each month would benefit in the long run. While there would inevitably be periods of paper losses during downturns, continued regular buying is likely to ensure that profits are generated in the long run.
Psychological effect
While trying to time the market sounds like a great idea, in practice emotions can become obstructive. It’s extremely difficult to buy shares during a bear market. Likewise, it’s tough to sell during a bull market. Human emotions of fear and greed mean that many investors lose sight of their long term goals of buying low and selling high. Therefore, in many cases, they may fail to think and act logically during periods of real opportunity.
Through dripping money into the FTSE 100 on a regular basis, it’s possible to avoid the psychological effects of volatile share prices. Not only could it lead to higher profit than an investor who tries and fails to time the market, it may also provide greater peace of mind. Knowing that there will be further investments each month in the long run may help an investor to mentally reconcile the paper losses that they experience during downturns.
As such, it could be a sound strategy – especially for investors who feel unable to deliver on the idea of buying low and selling high.