Updated: May 20, 2022
With stock markets plummeting over the last year and a half and the fear of losing our job hanging over us, how is it possible to think about investing right now? Equity markets have more than halved. What is to stop them halving again?
"Invest regularly and stay invested"
There is no doubt that we are experiencing one of the worst bear markets in history and it may well continue for a little longer. But there is one thing that you can be absolutely certain of: this bear market, like all others before it, will end.
And when it ends, you will not want all your savings to be in the bank. Like many investors before you, you could end up missing the ﬁrst phase of the stock market recovery, a phase that is usually both swift and substantial.
You may tell yourself that you.re happy to wait. And that’s a natural reaction given the severity of this bear market, which has sent us all running for cover. But missing out on this phase could signiﬁcantly affect your long-term investment returns. The trick is to ignore market volatility and maintain some stock market exposure in a disciplined, relatively stress-free way.
Which is where the MIP (Monthly Investment Plan) comes in. By feeding money into the market at monthly intervals the MIP allows one to build positions gradually. If markets stay soft, well, the more your money will buy at any given time; and if they go up, then your purchasing power goes down but the overall value of your portfolio increases.
The great thing about an MIP is the control it offers. You ﬁx the amount you want to invest; you decide where you want to invest; and you can stop and re-start the plan at any time. It’s not a magic solution but it can help you avoid a lot of the investment mistakes that we are all prone to. Now read on!
Dollar cost averaging
Broadly speaking, there are two types of investing: systematic and non-systematic. The ﬁrst is a methodical approach and does not rely on one’s emotions or gut feelings. You put a ﬁxed amount into the fund every month, regardless of market behaviour and the price of units. If the price of the fund goes down, you buy more units; if it goes up, you buy fewer units.
This approach is called dollar cost averaging. Simply it means that your average unit cost will be less than if you made an equivalent lump sum investment at its unit cost. Put another way, as prices fluctuate, you get
The statistical effect becomes more obvious over time, especially in volatile markets, as the illustration below shows.
When emotion rules
Each year Dalbar, Inc. publishes an analysis of the effect on performance of investors. buying and selling of US mutual funds. Although the numbers vary from year to year the message remains the same: the average investor earns signiﬁcantly less than mutual fund performance would suggest.
Why is this?
The answer lies in market timing. We all flatter ourselves that we can spot the right moment to enter or exit the market. In practice luck, mostly bad, plays as much a part as skill. Indeed, while the age-old advice to buy low and sell high is simple and obvious, our very unsystematic behaviour leads many of us to do the opposite.
Dalbar shows that over the 20 years ended 31 December 2007, the average equity fund investor would have earned an annualised return of just 4.5%, underperforming the S&P 500 by more than seven percentage points per year! Furthermore, $10,000 invested in equity funds in proportion to actual flows would have earned just $14,011, compared to $21,036 from a systematic approach that spread the $10,000 investment evenly over the 240 months (see chart below).
So your best course of action is to invest regularly and stay invested.
Setting up your investment plan
Before you make any investment, it is always worth asking what your objectives are and whether they are suitable. A ﬁnancial adviser can help. A good investment plan should consider both the external and internal aspects of investing, ie the different types of investment that are available and your attitude to risk. The biggest problem nearly every investor encounters is a mismatch between his return expectations and risk tolerance.
Risk and return are generally correlated, and the longer you hold an investment the more apparent this should become. Broadly speaking, equity funds are more volatile than bond funds, and single country funds more volatile than regional or global funds. Money market funds are safer than either, but they aim only for cash-plus returns.
With an MIP there is an argument for weighting your MIP more to higher risk asset classes because of the smoothing effect of dollar cost averaging, with your investments going into the market over time. That does not mean however that you should conﬁne your investments to only one or two funds. There is nothing to prevent you from spreading your MIP across several funds; indeed, this may be sensible risk diversiﬁcation.
Because of their systematic nature, MIPs have become popular as a means of planning for speciﬁ c events, like retirement or your children’s school fees. In fact, MIPs may be appropriate for any kind of long-term contingency; other examples could include medical or parent care expenses.
The take-up of MIPs varies across Asia. In Korea millions of workers have installment plans which make up significant net flows into the stock market. In Australia, Malaysia and latterly Hong Kong, which have payroll-deducted pension schemes, contributions in effect behave like MIPs; whether self-selected or managed by a third party, they get funnelled into the market on a regular basis.
Even if you do make payments into a pension scheme, the case for investing in an MIP still stands. For unlike the west, where the welfare state is well-established, Asia does not have deep coverage hence savings rates tend to be higher. But these are not always well used. An MIP helps nudge you in the direction of growing those savings in an affordable way.
What should you consider when investing? Some internal aspects to cover when establishing an investment plan:
. What are your investment goals and needs?
. How old are you?
. How strong is your ﬁnancial position?
. How high is your tolerance for short-term volatility?
. To what extent do you need to be able to convert your investments into cash at any time?
. When will you need the money you have invested?
. How much diversiﬁcation should you seek?
. What sort of investment style are you looking for?
Cash is king?
Recently you may have heard cash is king, an expression that refers to the fact that holding cash is the best thing to do when risky assets are falling in value, as they have been during the recent bear market. It may be true that cash has been the safest place to keep one’s savings in recent months. But with everyone wanting to reduce expenditure and hold cash, deposit rates have fallen to close to zero. So, you’re hardly getting any return any more for holding cash. In fact, after taking account of inflation, returns might even be negative.
At the same time, the price of risky assets such as corporate bonds and equities has fallen, and they now offer attractive yields much more attractive than the yield on cash deposits. True, the price of risky assets can fall further in the short term, and if companies cut their dividends the yield on their shares will not be as high as was thought. But we are getting closer to the point when holding risky assets may be more rewarding than cash in the bank.
Published in Aberdeen marketing
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.