By Duane Littler, Executive of Business Development at PPS Investments
In times of current market volatility, investors should ‒ among other risk mitigation strategies ‒ reduce the risk of buying assets at the top and (as a result of emotions mostly) selling at the bottom.
One effective approach is investing fixed amounts at regular intervals over a long period, thereby spreading risk over time. This concept is referred to as rand cost averaging (RCA).
In an ideal world, investors would invest when unit prices are low and sell when they are high to maximise returns. However, in times of volatility, unit prices can change dramatically on a daily basis. Attempting to “time the market” – at any point – is seldom fruitful. That is why rand cost averaging is a good discipline technique and allows one to smooth out unit price fluctuations over time.
With rand cost averaging, the amount of money invested monthly remains the same over time, but the number of unit 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. Thus, during a bull run, rand cost averaging might not be the best strategy, but the longer markets perform well, the more pertinent rand cost averaging becomes as an investment strategy.
However, when markets are declining, you receive more units per rand invested due to the lower unit cost price. Bear markets and bull markets can last for a long time and it is unlikely that an investor will be able to determine the turning point.
Employing a recurring investment strategy in a variable market also tends to result in a lower average unit cost price. While markets can be volatile, they generally moves in the same direction over long periods of time.
Rand cost averaging is a long-term strategy and the ultimate end value is the important part.
Regular debit order investment
A suitable investment vehicle to capitalise on the benefits of rand cost averaging is a collective investment scheme such as a unit trust via a regular debit order. However, it can also be applied to investors who are skeptical of investing a lump sum all at once due to the fear of falling prices in a volatile market.
Once it is set up as a debit order it is automatic. Initially, small debit order contributions may not seem significant, but they enable investors to foster a good savings habit. Over time these contributions accumulate and grow thanks to the power of compounding. A lump sum can also be made into a money market fund where predetermined fixed amounts can be debited (say monthly) and invested in the chosen unit trust to benefit from the rand cost averaging strategy.
Another reason to employ rand cost averaging is because systematic recurring investments reduce the temptation to time the market while receiving the benefits of lower average unit cost prices. It is an affordable strategy because it works for low monthly premiums and it can be profitable as you buy more units in your collective investment scheme when prices are low.
This article first appeared in City Press