If you are new to investing or are somewhat concerned about how the markets are likely to move given the current economic challenges, making smaller, regular investments might be a good way to start.
Most of us will face the following dilemma when planning our wealth: should I invest my money through smaller, regular amounts? Should I go for a lump sum investment and invest my money all at one go?
My contribution will aim to explain the pros and cons of regular investing, how it works and when to combine this strategy with a lump sum investment.
What is regular investing?
As many long-term investors will tell you, market fluctuations are inevitable and financial markets will suffer from declines. Some of these bouts of fluctuations in prices, which we also refer to as volatility, may be gradual with others being sharp and sudden.
Going through these patches of volatility may leave you concerned, especially when you cannot predict what is round the corner. This may lead you to not invest at all or to redeem your investments with a high probability of enduring investment losses from buying high and selling low.
An important strategy to help prevent this is to make smaller, regular investments that will help to even out the highs and lows caused by short-term market volatility and smoothen your ride.
Let’s look at the following example. Imagine you are investing monthly into Investment A, with a starting price of €100. Market volatility will cause the price to fluctuate each month and over the first three months, the price of Investment A records a low price of €95 and a high price of €110. If you had invested €100 per month, you would have paid an average of €103.33 for your investment.
What are the pros of regular investments?
Regular investing helps make decisions easier. If you take a look at any stock market chart, you’ll see that prices go up and down all the time. Regular investing means you don’t have to worry about perfectly timing every trade, which is almost impossible. That’s because it averages out the asset price you pay in the short to medium term, as shown in the example earlier on.
Most of us lack the expertise, resources and time to constantly evaluate whether it’s the best time to invest. Investing regularly without worrying about the price can relieve the anxiety of making poor decisions when navigating the markets over the longer term.
Regular investing helps make decisions easier
A regular investment strategy helps lower risks with your capital and investment journey. Here is why. With regular investments, you may get fewer units when prices are higher, but when prices drop, your regular, fixed amount buys you more.
This reduces your risk of investing a lump sum amount at the wrong time. With this disciplined approach, your regular investments will help to average out the price over time. And you won’t just benefit from averaging out the unit price. By adopting a long-term investment plan, you can also seize the opportunity to ‘buy low’ during periods of downturn − and reap the rewards when the markets recover.
You might think you need a huge amount of capital to begin investing, but that doesn’t need to be the case. Regular investing lowers the barriers to enter the world of investing, and a regular investment into a mutual fund will also provide you with a professional fund manager to select shares from different companies. Mutual fund investing helps you diversify your investment so that your entire balance won’t be adversely impacted if you’ve got one single stock that’s underperforming.
All this sounds great, but is regular investing the golden rule to follow? Well, there are two sides to every coin.
And what about the cons?
Investing regularly is not a guaranteed strategy.
While averaging the cost of the unit price can minimise fluctuations, it doesn’t guarantee returns. Like any other investment, a persistently underperforming fund will not help you profit from it, so it is very important to carry out regular reviews of your holdings with your financial adviser.
When the market is on a strong positive run, averaging the price through regular investing might not provide you with the best return potential. If financial markets are showing a consistently strong uptrend, then you’re likely to get a higher return by making a lump sum investment, instead of doing it in smaller intervals. Again, it is important to seek professional advice through your trusted adviser.
With this in mind, you could also choose to use a mix of both approaches. For example, you can use regular investing to build up your capital and make lump sum investments during market downturns when you feel there is a good opportunity to ‘buy low’. Either way, the best strategy is to take a long-term view of your investment strategy and to seek professional advice through your trusted financial adviser.
Konrad Borg is head of wealth products, advice and sales fulfilment, HSBC Bank Malta plc.