When the road takes a downhill turn, hold on for the ride

Q: Thirty-odd years ago, I set up an MFL Mutual Fund account. I have not been a regular contributor, often taking long breaks because of changes in my financial circumstances.

Given the current times, the fund is losing significant amounts of money quite rapidly — $20,000 in the past few weeks. My question is, should I stop, or at least reduce my contributions at present until the market starts to recover? I currently direct debit $100 a week.

A: Before most readers skip past this Q&A because they know nothing about MFL Mutual Fund, it’s basically just another savings fund. What I say also applies to KiwiSaver and any other investment to which people make regular contributions.

As long as a fund’s returns are volatile — they move up and down with market movements — investors benefit from continuing to contribute a regular amount regardless of what the markets are doing.

Your fund, which invests mainly in shares and listed property, certainly qualifies as volatile. So let’s look at what happens when you regularly drip feed $100 into it.

Making up some numbers to keep it simple, we’ll say units in the fund were worth $10 each earlier in the year. So one of your $100 deposits bought you 10 units.

Now, though, the units are worth only $5, because of the downturn. So your $100 buys you 20 units. So where are we?

● Over the two deposit periods, you’ve bought a total of 30 units.

● You’ve paid $200.

● The average unit price is $7.50 — halfway between $10 and $5.

● But your average price is $200 divided by 30 units, which is $6.67.

How come you got such a good deal? Because you bought more when they were cheaper.

This is sometimes called dollar cost averaging. Real-world examples are of course more complicated, but the principle is always the same. If the unit price fluctuates, as long as you keep putting in the same amount regularly, you’ll end up buying bargains when the market falls.

It means that when the market recovers, you’ve got a lot more units than if the market had just sailed along smoothly. And more units means higher returns. Ups and downs are good — but only if you keep making those regular deposits.

The same thing applies if you’re buying shares in a company.

Other reasons for continuing regular contributions:

● You’re getting the money into the fund, rather than having it sit around earning next to nothing in a bank account, or being spent. That’s how to build up a decent sum for retirement.

● It’s good to keep a savings habit going. Once you break it, you might not get around to starting the contributions again.

Gains follow losses

Q: My super funds have reduced by 7 per cent in the past two months and the fund is spread across 60 per cent high growth and 40 per cent conservative.

I seem to be paying in contributions for them to lose money. Should I reduce my contribution rate to the minimum until the fund recovers, then make a lump sum catch-up contribution? A: No! See the Q&A above.

But I also wanted to address your worry about your contributions losing value. If we go back a few weeks, sure, you would have seen that your balance had declined week by week. But never assume that will continue.

In fact, by now it’s quite likely your balance has been growing again. As I said above, sharemarkets have regained about half of their losses, and even more in New Zealand.

What will happen next? A while back I was looking at NZX50 data back to 1991. (See table). In six of the 29 years, the New Zealand market went down, although losses were only 8 per cent or less in all but one downturn — the global financial crisis (GFC).

And then, in all but the GFC, there were really strong gains the following year, ranging from 13 to 24 per cent. Big relief all round.

In the GFC, the index dropped a smidgen in 2007 but then a horrible 33 per cent in 2008. But the year after saw a very healthy 16 per cent rise.

I’m not saying we’re going to get out of this downturn fast. There could be another big fall first, but maybe not. Nobody knows. In the end, though, the market always heads back upwards.

By stopping contributions, then picking when to put in that lump sum, you’re trying to time the markets. That’s not a winning strategy, as explained in today’s first Q&A.

Just keep up the regular contributions through thick and thin. In the long run, it’s great to be able to look back and say, “I bought some cheaply”.

You should get credit, though, for planning to make a catch-up contribution, rather than just stopping altogether.

Far from crazy

Q: I’m a 30-year-old who has recently received a $17,000 windfall.

I want to invest it in index funds, but feel nervous about dropping it all in at once. I’ve started with $2000 a week (via InvestNow, half domestic equities, half international equities), and plan to keep doing that until I’ve spent $16,000, at which point I’ll revert to my usual $100 to $200 a week.

Am I mad? Should I just put it all in at once, or should I space it out over more time?

A: Far from being mad, you’re doing really well.

When you have a lump sum to invest, the argument for drip feeding the money is not as strong as when you’re making regular investments into KiwiSaver or other funds.

That’s because you’ve got money sitting there, in the meantime, probably in a bank account earning next to nothing. On average, it would earn more in the index funds.

The trouble is, particularly in volatile markets, that you might deposit the whole lot right before a market downturn.

In the long run, this won’t make all that much difference — and if you’re investing in share funds it should always be for the long run. But in the short term, it would be really annoying to see that happen. So it’s partly for psychological reasons that I recommend drip feeding a lump sum.

If you do that, though, do it over just a couple of months — as you’re doing — so you don’t miss out on the likely higher returns for long.

You’re also doing well by investing partly in New Zealand shares and partly in international ones. That gives you good diversification.