Cost average effect: Invest for the long term instead of speculating

The cost-averaging effect can reduce the risk associated with long-term investments. Find out how this works and why you can benefit from price fluctuations here. So you can spend more on the new Bizzo Casino, or have more to invest.

The cost average effect only works with long-term savings plans

The cost average effect is a simple mathematical formula that can have a real impact on the success of your investment. The effect counteracts investment risk when stock market prices are on a roller coaster ride.

The cost average effect, also known as the average cost effect, can occur when you regularly invest the same amount in securities. You can achieve this, for example, through a monthly savings plan with a fixed amount. However, the effect does not work if you invest a lump sum. The speculative risk remains in full. That does not mean, however, that you cannot make a profit from speculation.

Savings plans can usually be adapted very flexibly and tailored to your personal goals. For example, you can invest passively in a fund every month through an ETF savings plan. Over time, the portfolio grows through regular purchases, even with small amounts. Fund savings plans usually run for several years or even decades if you are saving for a private retirement provision.

By the way: With a sustainable fund, you only invest in companies whose values are consistent with environmental protection and human rights. An ethical bank can advise you on sustainable investments. Be sure to clarify your expectations and personal financial situation before you start a savings plan.

What exactly does the cost-averaging effect do?

The cost average effect works with long-term savings plans. A fund savings plan that allows you to take advantage of the cost-averaging effect works as follows: For example, you buy fund shares for $100 every month. The total amount remains constant, even if prices rise or fall. Accordingly, you sometimes receive fewer or more shares for your $100.

The cost average effect then has the following effect:

Average costs fall – Compared to other types of investment, the average price of fund shares is often lower. This means that even highly speculative securities or strong market fluctuations can still be profitable. Other savings plans include those with fixed numbers of units. In this case, you buy the same number of fund shares every month.

Reduce “timing risk” – Stiftung Warentest explains that savings plans with fixed amounts have an advantage over one-time investments due to the cost-averaging effect. This effect means that it doesn’t matter whether you start investing when the price is high or low. With one-time investments, on the other hand, timing is everything. To find that, you need to know how the price has developed in the past. In most cases, you also need a bit of luck to buy or sell at exactly the right time. If you misjudge the market, the investment may result in a loss instead of the hoped-for profits.

Calculating the cost average effect

To calculate the cost average effect for wealth accumulation, you first determine the average cost of the savings plan. To do this, proceed as follows:

• At the end of the savings period, write down the investment amount. This is the sum of all your payments into the savings plan.
• Divide this by the total number of shares you have purchased.
• The result is the average market value or cost average at which you purchased the securities.
• You can better understand the effect of the average cost by making a comparison: What would have been the result if you had invested the entire saved amount at once or in a savings plan with fixed additional purchases of shares?

The following calculation example shows you exactly how this works and where the cost average effect comes into play. The three types of investment mentioned above are compared:

Example 1 – Monthly investment of a fixed sum of 100 euros.

Example 2 – Monthly investment in one fund share at a time.

Example 3 – One-time investment of €1,000. In the example, the investment remains in the securities account for the same period of time as in examples 1 and 2.

Note: The sample calculation is simplified. It does not take into account the costs of the financial institutions. The issue price is also set equal to the selling price. In reality, there are always slight differences here.

The examples show the progression over a shortened period of 10 months. A real savings plan will rarely run for less than a year.

The cost average effect benefits from fluctuating stock market prices

The cost average effect benefits from fluctuating stock market prices. With the fund savings plan in example 1, you invest 100 euros over a period of 10 months. At the end of the period, you have invested a total of 1,000 euros. In the example, you would now sell these again.

During this period, the price has fallen and risen again, which is a normal development on the stock market. You start at 100 euros. Coincidentally, at the end of the term, the price has also returned to 100 euros (note: this only happens to a limited extent on the real stock market).

This is where the cost-averaging effect comes into play:

When prices are low, you benefit and add to your portfolio accordingly.

For a total of €1,000, you have purchased 10.64 fund shares after 10 months (example!).

On average, the price of the fund shares over the term was €93.97. This is the cost average in your savings plan.

If you now sell all your shares for €100, you will receive €1,064.22. In example 1, you have made a profit of €64.22 solely through the cost average effect.

For comparison:

In example 2, you make a profit of €30 because you only had to invest €970 over the term instead of €1,000. In terms of total expenditure over the 10 months, you also benefit from the lower prices in the meantime, but not to the same extent as in example 1. The leverage of the cost average effect is the higher number of units you purchase in total.

In example 3, you do not make a profit.