One of the most underrated investment tools at your disposal is the humble debit order which can make a significant difference in your journey to financial freedom.
We often associate investing or getting financial advice with needing to have a large lumpsum to start with or we put off seeking guidance until we think we have enough to warrant going through the advice process. This article will highlight the importance of having a simple debit order in place, whether you are starting your investment journey or have already been investing for several years.
Firstly, get started!
Against the backdrop of South Africa’s poor savings rate, it is critical that we create an investing culture, but many would-be investors fall at the first hurdle, that is, getting started with a lump sum investment amount. A debit order works equally well – especially when you are trying to build a savings habit. Remember that life is not a rehearsal – we have one chance to make sure we not only live life to it’s fullest, but that we also make provisions for when the pay checks stop arriving each month and we are forced to live off what we have invested over the years.
Debit orders start at R1,000 per month and one of the best outcomes of having one in place is that your saving/investment decision is prioritised as money gets put away at the beginning of the month, before life gets in the way.
You could earn better returns with a debit order.
We all know that markets are volatile and our existing investment values fluctuate daily, so the idea behind a regular debit order is that we continue to invest at different price points over time which smooths out our exposure to volatility. A further benefit of using a debit order is that you can reduce timing risk. The biggest predictor of whether an investment will be successful is the price you pay for it.
We are currently going through one of the most difficult investment periods of recent times, every sector around the world is down year to date given the problems we are facing from rising inflation and interest rates to the war between Russia and Ukraine and the global food and energy shortages that have resulted. Naturally, our instincts kick in and we start thinking about withdrawing from the markets and moving money into cash to ride out the storm. If you take a step back and think logically, investments can be simplified to quite literally, buy low and sell high. If you decide to sell out when markets are down, you are going against the absolute basics of investing. On the other hand, these types of markets represent a fantastic buying opportunity as prices are low and if you have an adequate time horizon you stand to benefit from what the world is going through. Having a debit order in place through this type of market environment is a brilliant way of inadvertently buying low and reducing the average cost of your investment over time.
When you invest, you are essentially buying units within the unit trust. The price of the units varies from day to day. A lump sum payment gets you only that day’s price, which may be high and means you get fewer units. But timing the market perfectly is very difficult to do and waiting for the right moment to invest can mean you miss out on the compounding benefits of being in the market: each month you put off investing waiting for the perfect moment is a lost opportunity.
A debit order solves this problem by allowing you to get the average price of all the months you invest, which is called rand-cost averaging. When you use a debit order you sometimes pay a high price when the fund is doing well, and you get fewer units, and sometimes you pay a low price, and you get more units. Over time you pay the average price.
You have heard us go on about not being able to time markets and that you should rather focus on your time in the markets to give yourself a better investment outcome. A debit order is the perfect example of this message.
Building a habit and taking emotion out of it
Using a debit order takes the emotion out of your decision-making. You don’t have to think about it or start the investment process again. Of course, you need to maintain your debit order – but the habit of investing builds up automatically and over time your budget adjusts. If you need to make changes in your investment, such as when you receive a bonus, you can also make a once-off additional contribution or change your debit order.
The most important thing to remember is that the best time to start your investment is now. Trying to accumulate a lump sum may mean that you miss out on returns in the long term
The visual benefits of having a debit order
Below is a very simple comparison that depicts the benefits of having a regular debit order in place when trying to build up wealth – whether it be goal specific or retirement focused. Let’s assume you invest R1 million and have no debit order in place. In 10 years’ time, given the assumptions of a return of 10% and inflation at 5%, your capital would grow to R1,519,954 in real value. If you made the same investment but also added a R1,000 debit order that increased by 5% each year to keep up with inflation, your capital value would grow to R1,742,081. This represents an additional capital value of R222,127 whilst you have only contributed an extra R150,934 via the monthly debit orders.
