ARTICLE WRITTEN BY DUANE NICHOLLS CFP®
If someone told you that they were happy the markets were down, whilst they were still investing, you would think that they have lost the plot. However, after reading this article you might tend to agree with them.
When it comes to investing, it pays to realise you're in a long-term game. As a result of this, you don't want to be stressing about the markets daily moves. Hence a little theory called rand cost averaging.
Firstly, here are some advantages of recurring investment strategies and importantly why to keep them going:
1) As you invest every month, you don’t risk being left on the side lines while the market runs. You’re adding to your investment every month.
2) If the markets fall, you haven’t invested all your capital in one lump sum that will take a large knock. You don’t want to buy high, and sell low.
3) It’s an easy and affordable way of building long-term wealth.
4) By investing (buying units) every month, you’re able to secure below average market unit prices. #RandCostAveraging
Let’s look at the last point in more detail….
With Rand cost averaging, the amount of money invested monthly remains the same over time, but the number of units purchased varies based on the unit price.
When markets are up, you receive fewer units for every Rand you invest because of the higher unit price. So, when markets are down, you receive more units per Rand invested due to lower unit prices.
Employing a recurring investment strategy in a variable market also tends to result in a lower average unit cost price.
Let’s take a look at 2 scenarios…
Scenario 1: investing in a market experiencing steady growth. Scenario 2: investing in a market experiencing variable growth.
Let’s say you decide to invest R1,000 per month. Off the bat the unit price of Portfolio X is R100. In the first month, you pay R100 per unit and receive 10 units for your R1,000.
In the second month, the unit price has increased by 1% and so now you pay R101 per unit and received 9.9 units for your same R1,000.
Say this continues for a year (12 periods) as per the table below, resulting in less units being bought for every R1,000 invested.
Now if you add this all up you’ll notice you would have bought 113.68 units at an average price of R105.56. (R1,000 x 12 premiums ÷ 113.68)
At the end of the first year your investment value is sitting at R12,731.74.
Let’s start with the same introduction…. You decide to invest R1,000 per month. Off the bat the unit price of Portfolio X is R100. In the first month, you pay R100 per unit and receive 10 unit for your R1,000.
However, this time the markets begin to drop, and in the second month, the unit price has decreased by 2%. Therefore, now you pay R98 per unit and received 10.20 units for your R1,000.
As per the table below we depict a scenario where the markets are more variable. First declining and then picking up. Importantly the end unit price is the same as that of the first scenario (R111.57), yet this time resulting in more units being bought over the same period.
Now if you add this all up you’ll see you beat the markets average unit price. You bought 119.78 units at an average price of R100.18 (R1,000 x 12 premiums ÷ 119.78)
At the end of the first year your investment value is sitting at R13,415.20
Rand cost averaging is a long-term strategy and the ultimate end value is the important part.