Michael D'Angelo- December 2019
Investors who watch the markets closely can get dizzy tracking all the ups and downs- and, as prices fluctuate (often unpredictably), it can be hard to stay focused on long-term plans. When markets drop, it can be very difficult to fight the temptation to sell. When markets rise, it can be equally as tough not to jump on the bandwagon and buy. Unfortunately the result for many investors is selling during market downturns following buying back in as the market rises.
A simple strategy can help investors ride out volatility and achieve better long-term returns. A systematic investing plan quite simply means investing the same amount of money regularly, no matter what the markets are doing. When prices are high, that amount buys fewer units. When prices are low, that amount buys more units. The average cost per unit tends to drop over time because the investor buys less at a higher prices and more at a lower price- which is why this approach is also known as dollar-cost averaging.
How it works
Here’s a simple example that shows how this systematic investing plan can benefit an investor. Let’s say Daniela commits to investing $100 in a mutual fund every week. As we are in a volatile time, let’s see how this method can benefit Daniela over the next two months:
|N/A||Amount Invested||Cost per Unit||Number of Units Purchased|
*The example used in this chart is for illustration purposes only to easily explain concept.
Total Investment: $800
Average Cost Per Unit: $9.26
Total Number of Units Purchased: 86.4
Over the eight weeks, Daniela invests a total of $800 and buys a total of 86.4 units. Her average cost would be $9.26/unit. Had Daniela invested her entire amount of $800 during week 1, her average unit cost would be $10 versus her current average unit cost of $9.26, savings of 0.74 cents per unit.
In hindsight, she could have done even better if she somehow knew that week 3, when the cost per unit was at its lowest, would be the best time to buy. In that case, her $800 investment would have bought 114.3 units, worth $1,028.70 in week 8. However, she could have also done much worse had she wrongly guessed that week 6, which was when the cost per unit was at its highest, would be the best time to buy. In that case, her $800 investment would have bought just 66.7 units worth $600.30 in week 8.
Not even the most skilled professional investors can say with certainty that markets have bottomed or peaked, so a systematic investing plan is a more disciplined approach than attempting to time the markets. By averaging the cost per unit over time and ensuring fewer units are purchased at higher prices, systematic investing can help investors achieve greater potential returns.
Why it Matters Now!
We are entering a period of increased market volatility, with global economic growth slowing and the possibility of a recession on the horizon. Economic slowdowns tend to weaken company’s earnings growth which may put pressure on stock prices.
Investors who are supported by the discipline of a systematic investing plan may be better able to take the long view through volatility. Perhaps the best thing about a systematic investing plan is that it’s automatic and unemotional, helping investors avoid the biases that affect us all and can lead to costly investment decisions. Instead of selling when prices are low, or “on sale,” investors with a systematic plan in place will continue buying in all market conditions. Instead of missing the best days for recovery because they’re out of the markets, those investors who remain invested and take advantage of lower unit prices will benefit greatly from the market volatility.
Volatility is perceived in a negative matter which in reality, us as investors should embrace volatility and take advantage of it. By having a systematic investing plan in place, it will provide us with the proper discipline and award us with the potential for better returns.