By Raoul Ruiz Martinez features@algarveresident.com
Raoul Ruiz Martinez is a resident financial consultant for Finesco Financial Services Ltd., Glasgow. Finesco Financial Services Ltd is authorised and regulated by the Financial Services Authority (FSA).
Hopefully you would have read my last article on ‘Essential elements of repatriation’ and it remains my intention to continue on the same theme on behalf of the Algarve Resident’s serial readers.
Like many investment decisions, after you have spent a great deal of time looking at your choices, a final decision must be made whereby a leap of faith is required to press that “START” button.
What better time to kick off your plan of action when fear returns once more to the markets. Do you continue or draw back on proceedings?
As a situation in point, markets have run head first into a huge bear market over this summer thanks to the US debt problems and the continued EU sovereign debt crisis. The press and analysts have yet again been drawing parallels with the 2007-08 crisis and the elongated economic slumps experienced during the 1930s Great Depression and in Japan towards the end of the 20th century.
The fact is that investors who put lump sums into equity-based investments in 2010 have seen their values seriously hit since early July until the end of August, demonstrating the risks of one-off investments when markets become volatile.
As an example, the UK stock market (FTSE) has lost almost 12% on average in this period and investors now disagree whether a regular savings strategy will prove a more profitable strategy in the months ahead.
If investors had drip-fed their capital from before the summer of this year, they would have had less to lose and more to gain as, historically, regular monthly investments have proved more profitable in falling and fluctuating markets. Data from Lipper covering the last bear market – September 2007 to February 2009 – shows that regular savings outperformed lump sum investments.
If the regular savers continued investing to the end of 2009 – to benefit from the market rally in the second half of 2009 – their losses would have turned into profits over 10%. By contrast, lump-sum investors who stayed in the market until the end of December 2009 were still sitting on a loss unless they had restructured earlier in the year. However, over longer periods, evidence suggests that lump sums are more profitable – largely because markets have generally risen in the long term and lump-sum investors are fully invested from the start.
When market volatility is high, though, switching to a drip-feed strategy offers two clear advantages:
1. Eliminating market timing errors. When stock markets are rising and falling by more than 2% a day, timing a lump-sum investment becomes impossible. Even when the market is trading on a historically low valuation, a lump-sum investment can fall further, and take longer to recover its value. Investing regularly may eliminate the risk of losing a significant percentage of your total investment in a matter of days.
2. Pound-cost averaging. When prices are falling, regular savings can buy progressively more shares or fund units each month, and fewer when prices are rising. In any market apart from a prolonged bull run, this means a regular saver ends up holding more shares or units than a lump sum investor who bought at the outset, and at a lower average purchase price. As a result of this pound-cost averaging effect, the regular saver makes more profit.
The arguments against are equally as compelling in that drip-feeding is much more important when markets are high and could fall, than when they’re already low. Professionals and bullish investors with a lump sum are getting their money into the market now, while it’s cheap, even though they have to accept that further falls are likely.
For more cautious investors, you could consider future investments into a lump sum followed by regular savings over several months to protect against further market falls.
In short, only the most confident investors should risk a lump-sum investment, given the current volatility. If the market bounces back in the coming months, then a lump sum investment may be right for you and it may be beneficial to look at doing it now. However, for the vast majority, it would be better to drip-feed on a fixed term until you feel confident enough to put in a lump sum or on indefinite basis to suit your circumstances.
Past performance is no guarantee of future returns. You may not get back the full amount of your investment. This article is intended to provide a general review of certain topics and its purpose is to inform but NOT to recommend or support any specific investments or course of action.
Raoul Ruiz Martinez can be contacted at the offices of euroFINESCOs.a. either by telephone on 289 561 333 or on email Raoul.Ruiz@Finesco.com
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