If you are thinking about investing for the first time, or indeed even it’s not your first venture into the markets, it can be daunting. What if I pick the wrong strategy? What if the markets fall after I take the plunge? These worries can paralyse us into just doing nothing. Whilst doing nothing can sometimes be all too tempting, the impact of inflation (especially with the world we find ourselves in right now) can have a devastating affect on our long term savings. With interest rates still low, albeit slowly rising, we are not earning very much at all on deposit. If we apply even a modest inflation rate of 3% over the long term, we will steadily lose buying power over the years.

Enter the powerful principle in investing that is ‘Euro Cost Averaging’. Simply put, Euro cost averaging is an investment strategy which involves saving regularly into a particular investment at regular intervals over a period of time. This period could be over several months but usually years. This method or strategy can be ideal for those of us saving for the kids education, saving for a rainy day, or indeed maybe you have grandchildren and are taking advantage of the Annual Gift Exemption. Really any long term saver could benefit from this strategy.

To really understand how beneficial this investment strategy can be, we should ask the question ‘So how do most investors react in times of market uncertainty?’

Many investors are inclined to wait until things settle down during periods of volatile markets.  Some investors try to predict when the bottom of the market has been reached in an attempt to ‘buy the dip’. Other investors wait until confidence has returned to the market before investing. Interestingly and ironically, even when markets do recover, and confidence does return, these very investors wait for the market to fall again before committing to an investment, in the hope of picking up some bargains.

Such approaches to investing are flawed, as they lead to what could be termed ‘investor paralysis’, resulting in a delay in investing and being unable to fully participate in the benefits of a market that will eventually recover.

The principle of euro cost averaging provides a means of reducing the risk of investing during a period of market volatility. It helps to overcome the ‘investor paralysis’ often associated with a falling share market.

The following example serves to highlight how Euro Cost Averaging can work. I am using the example of €100,000 being invested in a standard ‘managed fund’. When we invest in these funds, we are essentially buying ‘units’. The cheaper the units at the time, the more bang for our buck.

First, let’s look at a once off lump sum investment of €100,000 over a 12 month period:

Month Unit Price Units Purchased Value
1 1.00 100,000 €100,000
2 0.80 €80,000
3 0.70 €70,000
4 0.75 €75,000
5 0.80 €80,000
6 0.85 €85,000
7 0.90 €90,000
8 1.00 €100,000
9 1.10 €110,000
10 1.15 €115,000
11 1.15 €115,000
12 1.20 €120,000

In the above example, we have demonstrated that shortly after investing the markets dipped and in this case took until August to come back to par. The investor held firm and by the end of the year was rewarded with a profit of €20,000.

But what would have happened if he had made 12 equal investments of €8,333 instead?

Month Amount Invested Unit Price Units Purchased Value
1 €8,333 1.00 8,333 €8,333
2 €8,333 0.80 10,416 €14,999
3 €8,333 0.70 11,904 €21,457
4 €8,333 0.75 11,111 €31,323
5 €8,333 0.80 10,416 €41,744
6 €8,333 0.85 9,804 €52,686
7 €8,333 0.90 9,259 €64,119
8 €8,333 1.00 8,333 €79,576
9 €8,333 1.10 7,575 €95,866
10 €8,333 1.15 7,246 €108,556
11 €8,333 1.15 7,246 €116,889
12 €8,333 1.20 6,944 €130,304

 

In this example, the investor has made more at the end of the 12 month period. This is because he was able to overcome the investor paralysis by committing at the outset to a set regular contribution. He then bought in throughout the market turbulence and when the market rebounded, he has reaped the rewards.

We could compare this to something close to my heart – a nice bottle of wine. Let’s say my favourite bottle of wine usually retails at €20 per bottle. At this price I will buy one. Now on my next trip to the supermarket, the same bottle is on sale at half price. Happy days – I’ll buy two!! Now I have three bottles for the price of two. This is Euro Cost Averaging and is the same principle as investing regularly. Thankfully the units we buy in our investments will last longer than the wine in my press!

So if you find yourself disappointed with the returns you are getting from your savings account, maybe it’s time to think about putting your long term money to work.

For more information and advice on what strategy is best in your circumstances, speak to us here in Wealthwise Financial Planning.

By Jennifer Hardman BA LLB QFA SIA, Senior Financial Advisor, Wealthwise Financial Planning