You Have To Be In It To Win It!
“The true investor welcomes volatility … a wildly fluctuating market means that irrationally low prices will periodically be attached to solid businesses.”
It’s not surprising that first-time investors often worry about the timing of their initial stock purchases. Getting started at the wrong point in the market’s ups and downs can leave you staring at big losses right off the bat.
But take heart, whenever you first invest, time is on your side. Over the long haul, the compounding returns of a well-chosen investment will add up nicely, whatever the market happens to be doing when you buy your first shares.
Don’t waste time
One of the biggest dilemmas investors face is market timing. Jumping in and out of markets on a regular basis not only requires constant monitoring of daily events but also requires the skill to act on such events.
The message here is that it’s impossible to time markets perfectly, so it’s best not to attempt. What we want to do is improve our chances of entering the market at the right time.
One way to achieve this is to spread or drip-feed one’s money into the market as oppose to investing it all in one go. In fact during volatile times this strategy allows one to benefit from what is known as ‘pound cost averaging/dollar cost averaging/euro cost averaging’ which is essentially what you do with a monthly savings plan.
The benefit of pound cost averaging
The concept of pound-cost averaging is simple; the term simply refers to investing money in equal amounts at regular intervals. One reason pound-cost averaging is so attractive is that it forces you to invest no matter what the market is doing, thus helping to avoid the poor decisions most people make when trying to time the market.
When the stock market is going down, lots of people become fearful and reluctant to put money into stocks. That may help avoid some losses in the short term, but when markets eventually start going back up someone who has avoided stocks will lose out on the gains.
Those who invest a fixed amount every month, on the other hand, will be in a much better position to benefit when the market bounces back, and meanwhile they’ll often be buying stocks at bargain prices.
How to benefit from a volatile market
While pound cost averaging can reduce your risk it is a strategy that does benefit from volatile markets, which is essentially what we have at the minute. The more the market swings the greater the benefit to somebody using pound cost averaging.
For example if the market swings down every other month then on each downturn you would buy more shares or fund units each month as their prices decreases but your monthly payment stays the same. This would then be worth more on each upturn of the fund as your total amount of units is considerably higher.
In a bear market pound cost averaging allows you to build up an investment poised to benefit from a recovery without having to worry about trying to work out when the bottom of the market will occur. However with this strategy in a bull market, the opposite is true: pound-cost averaging prevents you from getting carried away and putting too much money in stocks that may be too expensive and poised for a fall.
In the raging bull market of the late 1990’s lots of otherwise rational people were swept up in the mania and loaded up on stocks trading at exorbitant prices; when the market crashed, many of those investors got badly burned. Investors who pound-cost averaged their investments missed out on some of the upside at the height of the bubble, but they were generally in much better shape when the market went south.
This is an important point to note: pound-cost averaging aims to reduce volatility but this does not mean it will increase total return – this strategy enables you to avoid the worst of the market’s moves and therefore means you’ll also miss the highs. Although this is a small price to pay for the added security that pound cost averaging brings to investment decision-making.
How should I do it?
If you decide that pound-cost averaging is a good idea the easiest way to set it up is via a regular monthly contributions into some form of investment savings plan.
Most people find it easier to stick to a pound-cost averaging plan that’s set up to work automatically. You may already have one of this in operation if you have a work based pension, if you don’t then it is simply a case of going and talking to a financial advisor who can advise you on the correct plan for your needs.
Feel free to let me know what challenges you are facing with your finances right now so I can develop posts and resources to help you specifically.
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I would be happy to review your current financial plan, offer some tips for creating one or answer any questions you might have pertaining to your investments.
About the author
Colin MacGregor is an independent financial advisor with over 10 years experience in the advisory sector and has been based in Prague, Czech Republic since 2009.