‘Buy low and sell high’ is the cornerstone of investing. It is a phrase used during uncertain times like these to encourage investors not to capitulate and sell out of their equity investments. Alternatively, it serves as the perfect piece of advice to those with cash on hand and who can take advantage of the hugely suppressed share prices currently on offer. While investing theory may seem simple, execution is where many fall short. A significant phenomenon to take into consideration is the past attempts and failures of investors to time markets – trying to pinpoint when markets are at their lowest and vice versa. This never works, history and studies prove this to be near impossible. So, what is a safer alternative to ensure investors are taking advantage of these types of situations and making the best long-term investment choices to benefit them in retirement?
The answer may lie in ensuring investors have debit orders as part of their investment strategy. While the minimum of R500 per month may not sound like much and is often used as a starting point when deciding to invest, it may alleviate the stress of market downturns by reminding investors that they are buying into discounted markets and they do not need to worry about timing markets or being forced into making decisions based on panic or fear.
Debit orders ensure investors remained disciplined in their investment strategy by having money invested before it gets caught up in their monthly expenditure. They ensure investors remove market timing from the decision process and ensure they slowly but surely build up capital and move them one month closer to a comfortable and enjoyable retirement.
An investment principle, termed the ‘rand-cost averaging principle’ refers to a wealth-building strategy that involves investing a fixed amount at regular intervals over an extended period into an investment vehicle that has a fluctuating price, such as a unit trust. By investing a fixed rand amount on a regular basis, one buys more units or shares when prices are low and fewer when prices are high.
While small monthly contributions may not seem impressive at first glance, they enable investors to adopt the habit of saving which can really add up over the course of a lifetime due to the power of compounding.
John wants to invest R100 per month in a unit trust for the next 20 years. John pays R100 over to a unit trust manager who buys him a certain number of units in the unit trust.
On 1 January 2020 John buys 100 units. His 100 units is made up as follows: the price of one unit in the unit trust on 1 January 2020 was R1 thus John’s R 100 investment bought him 100 units in the unit trust (100 units x R1 = R 100).
The unit price of a unit trust changes daily and can either go up, down or remain relatively stable depending on the type of unit trust and the activity within the markets in which the unit trust invests.
On 1 February 2020 the unit price of the unit trust in which John had invested was R2 as the markets had improved. On this day John buys another R100 worth of units in the unit trust. This time his R100 only buys him 50 units (50 units x R2 = R100). On 1 February 2020 he has invested R200 in total and he owns 150 units in the unit trust. His total investment is valued at R300 (150 units x R2) as at 1 February 2020.
On 1 March 2020 the unit price dropped sharply from R2 to 50c per unit due to unfavourable market conditions. On 1 March 2020 John invests another R100, however this time his R100 buys 200 units (200 units x 0.50c = R100). John now owns 350 units, but the unit price has fallen and so his total investment has decreased. On 1 March 2020 the total value of John’s investment stands at R175 (350 units x 0.50c = R175). But John is investing for the long term and therefore ignores the short-term market noise, sticks to his 20-year investment plan, and does not sell due to panic, fear or market pressure.
By 10 March 2020 the unit trust price has recovered substantially and moved to R3 per unit taking John’s total investment value to R1 050 (350 units X R3 = R1 050).
John patiently and consistently invested the same amount every month and thus was able to take advantage of accumulating more units in the unit trust when markets fell and hence improved his total wealth. Instead of staying out of the markets when times turned bad, John applied the rand cost averaging technique knowing that it was a great opportunity to increase the number of units he could buy without having to invest more. When markets improved, he was ultimately better off and managed to substantially boost his overall wealth.
Markets will rise and fall over time. Instead of shying away from investing when times are bad rather apply the technique of rand cost averaging in order to really get ahead when things improve again.