Ashley Percival, CFP®
The stock market is known for its volatile nature. It’s not uncommon to experience rapid and severe decreases in share prices. Just think back to 2008/2009 when the FTSE/JSE All Share Index fell 45.4% from its high.[i] For some investors, it might have been paper losses,[ii] but nonetheless hard to swallow. Fortunately, there are strategies that you can employ to reduce your risk and to take advantage of declining markets. One of these strategies is known as Rand-cost-averaging.
What is rand-cost-averaging?
Rand cost averaging is a wealth-building strategy that involves investing a fixed rand amount at regular intervals over time in an investment vehicle that has a fluctuating price, e.g. unit trusts. By investing a fixed rand amount on a regular basis, one buys more units when prices are low and fewer when prices are high. A big advantage of this strategy is that it reduces the temptation to time the market, investing a lump sum when the market is at or close to its peak.[iii]
The most convenient way to take advantage of rand-cost-averaging is to invest in your chosen investment vehicle via a monthly order. Initially, small debit order contributions may not seem significant, but they enable investors to foster a good savings habit.[iv] Over time these contributions accumulate and grow thanks to the power of compounding.
If you have a lump sum available, you may want to invest it in a money market fund where predetermined fixed amounts can be debited and invested in your chosen unit trust fund to benefit from the rand-cost-averaging strategy.
A study conducted in 2009 by Plexus Asset Management reveals that that less than 22% of the 108 domestic equity unit trusts achieved positive returns over the year ending 31 July 2009. A total of 40 of the 85 funds that yielded negative returns for the year underperformed the FTSE/JSE All Share Index, achieving returns exceeding -9,4%.[v]
The results are quite different for investors who had opted for a rand-cost-averaging strategy. Had a lump sum been phased in over 12 months from 31 July 2008, not one of the 108 equity funds would have cost the investor money.[vi]
Although the period studied is relatively short, there is no doubt that rand-cost-averaging is a useful strategy to help you manage risk better. It also takes the emotional component out of decision making.
During a bull run when markets perform well, rand-cost-averaging might not be the best strategy. The strategy comes into its own when markets are declining as you receive more units per rand invested due to the lower unit cost price.
As counterintuitive as it may seem, if you are in the wealth-accumulation phase of your life, falling share prices should be welcomed.
___________________________________[i] https://www.psg.co.za/services/api/asset/downloadfile/2e08fb17-cd88-463f-a562-6887248edafc [ii] Loss which has occurred but has not yet been realized through a transaction, such as a share which has fallen in value, but is still being held. Also called unrealized loss. [iii] Dr Prieur du Plessis, Plexus group chairman. [iv] Simple investment with big benefits, Tandisizwe Mahlutshana, PPS Investments [v] https://www.fanews.co.za/article/investments/8/general/1133/rand-cost-averaging-proves-its-worth-in-declining-markets/6729 [vi] Dr Prieur du Plessis, Plexus group chairman.