Drip feed to limit stress
When equities are looking expensive or volatile, it’s particularly important to choose well between investing a lump sum all at once or phasing it in.
Independent financial advisor Paul Roelofse is a firm supporter of the latter: rand cost averaging (RCA). “There is no question about it. You must apply RCA,” he stresses.
Though Evan Walker of 36One Asset Management is positive on the longer-term outlook for equity, he also urges caution. “I would not deploy a big capital amount as a lump sum at present,” says Walker. “There is a lot of uncertainty about. I am advising clients to phase in over six months.”
Markets have had a lot of uncertainty to contend with of late. In Europe, Greece’s bankruptcy and threat to leave the eurozone have provided it in abundance.
Though Greece has been rescued from the brink by a €7bn three-month loan from the European Central Bank, the cliff edge is still there. Negotiations between the EU and Greece on stringent conditions for an €86bn bailout are ahead.
“The Greek saga isn’t over yet,” says UK financial advisory firm deVere Group’s CE, Nigel Green, in an e-mailed comment. “Big hurdles remain. Things can
19,00 go wrong. There will be a lot of noise in the negotiations.”
To add to the uncertainty, a 30% collapse of China’s domestic A share market in June wiped US$3 trillion off its value. It could be a warning signal of deeper, fundamental problems in China’s economy.
Green comments: “There is growing noise regarding China’s real economy, which is heavily indebted and slowing.”
For good measure, the US Federal Reserve (Fed) has thrown in its own dash of uncertainty: the timing of its first rate hike in eight years. Fed chair Janet Yellen’s has cautioned: “We could see a sharp jump in long-term rates.”
It would also be bad news for equity and makes for a market in which high volatility should come as no surprise. It greatly adds to the appeal of RCA.
In concept RCA is simple. In a unit trust, for example, an investor buys units priced to reflect the exact value of the fund’s underlying portfolio on a daily basis. When the portfolio’s value, and hence unit price, is rising, a given sum will purchase fewer units than when the portfolio value is falling. The same principle applies to exchange traded funds.
RCA provides no guarantee that the performance outcome will be better than a one-off lump sum investment. Indeed the odds of RCA being the best choice are less than 50:50.
A US study by asset management firm Vanguard shows that a lump sum investment produced better returns than a 12-month phasing-in strategy in 66% of the 10-year rolling periods between 1926 and 2011.
The situation in SA is similar, reveals research undertaken by Francis Marais, an analyst at Glacier by Sanlam. In his study he assessed rolling total returns from January 2000 until April 2015 using five phasing-in periods of from three to 20 months.
Marais found that a lumpsum investment would have produced a higher return almost 75% of the time. However, he emphasises: “This does not mean it [RCA] never works. It worked in four out of the 15 years and it worked well.”
Ultimately, opting for a lump sum investment or RCA is a matter of personal choice. For many, the choice of RCA will be based on their need to reduce the stress an ill-timed lump sum investment could bring.
Even a big lump sum investment made in late April ahead of the JSE all share index’s 10% slide had the makings of a very unnerving experience.