The stock markets have had a really grim start to the year. At the beginning of this week the JSE had fallen by more than 14% since the start of the year, and the US markets fell by more than 16% over the same time period. This has been mostly driven by fears around the Covid-19 coronavirus.
We talk about “buying low and selling high”, but our emotions often get in the way, and it is very difficult to invest a lump sum when there is bad news everywhere. However, investing monthly forces you to do exactly the right thing – you buy more shares at a lower price, resulting in a better long-term performance.
A study conducted by Plexus Asset Management after the global financial crisis began in 2008 showed that only 23 of the 108 domestic equity unit trusts achieved positive returns over the year ended July 31 2009, with some of them showing losses in excess of 9.4%.
However, the results are quite different for investors who had opted for a rand-cost averaging strategy. Had a lump sum been phased in over 12 months from July 31 2008, not one of the 108 equity funds would have lost the investor money.
By investing monthly, you achieve rand-cost averaging. What this means is that, by regularly investing a fixed rand amount, you buy more units or shares when prices are low, and fewer when prices are high. This means you are purchasing more shares or units at a lower price, which reduces the overall price you paid for the total number of shares or units in your account. With a debit order, you don’t need to worry about market timing or whether the market is overvalued because, if the market falls, you get more bang for your buck by purchasing more shares with the same amount of money.
|RANDS INVESTED||PRICE OF UNITS||UNITS BOUGHT|
|February: Market falls 15%||R200||R8.50||23.53|
|March: Market falls another 10%||R200||R7.65||26.14|
|April: Market recovers 10%||R200||R8.42||23.77|
|May: Market recovers 10%||R200||R9.26||21.61|
HOW RAND-COST AVERAGING WORKS
In the example illustrated in the below table, by the end of May you have invested R1 000, the market has fallen by 25% and, although it recovered somewhat, it is not back to the level it was when you started investing. Yet you accumulated 115.05 units and, at R9.26 per unit, that comes to R1 065.
This is the benefit of rand-cost averaging – making money in a falling market!
If you’d invested the full R1 000 in January, and thus bought 100 units, your investment would only be worth R926.
- It disciplines you to save. A debit order goes off your bank account before you can spend the money, and you learn to live off the money that is left in your account.
- Your savings grow over time. A relatively small debit order can become a significant amount of money over time. For example, a monthly debit order of just R200 (less than the cost of a meal out with the family) paid over 10 years will, thanks to the power of compounding growth, be worth as much as R40 000 if the investment grows at 10% a year.
- It reduces the risk of emotional investing. With a lump sum investment in units (shares), the timing of entering the market has a significant impact on the investment return. Our emotions increase the chance that we will invest at the wrong time – we tend to buy high and sell low as we get caught up in the emotions of investing.
- It protects your investment from the risk of bad timing because you buy when the market is up and when it is down. This kind of “phased-in” investing is known as rand-cost averaging, as it helps to average out the return on your investment.
- It reduces the overall price of your units. You buy more units (shares) when prices are low, and fewer units when prices are high, which reduces the overall price you paid for the total number of units in your account.