Smoothing

The idea behind smoothing is to reduce the risk and the volatility of your investment. Instead of simply sharing out what a collective fund makes or loses each year, a smoothed fund evens out some of the fluctuations in performance over the duration of your investment.

This is a defining characteristic of with-profits policies. However, the smoothing process, while simple in concept, is often very complicated in practice and is at the product provider's discretion.

The mathematics behind smoothing can be highly complex, reliant on a number of variables expressed over a time series. However, smoothing should not mean that the fund makes profits that you never get, instead profits are spread from one year to the next, with the long-term aim to pay out all of the profits earned by the fund over the long term.

Combining your savings with those of other investors in a collective investment allows you to get a better spread of assets than you would by investing on your own. Adding in smoothing should mean that the investment risk of a with-profits fund is lower than many other ways of investing in shares.

Smoothed policies that matured in the late 1990s performed well, having benefited from a 25-year period that including years (notably in the 1970s) of sharply rising prices. Over time, these high-inflation years are dropping out, to be replaced by more lower-return years.

Last Updated: April 2008 © Moneyextra.com

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