Coping with financial market volatility: Lump sum versus regular investing tactics
Despite concerns over slowing global growth, the ongoing trade war and the prolonged uncertainty surrounding Brexit negotiations, the first half of 2019 has been relatively kind to investors. Having said that, the month of May was hardly covered in glory as numerous challenges came to the fore.
Overall, equities were negatively impacted by the ramping up of trade hostilities as the US increased the tariff rate from 10% to 25% on $200m worth of Chinese imports. For its part Beijing responded by threatening to restrict the export of rare-earth minerals. Moreover, markets fell at the month-end as US President Donald Trump stated that all Mexican imports would be hit with a 5% tariff as of 10 June.
As a result, US shares were weaker, with the S&P 500 and Nasdaq falling as investors shifted their exposure to government bonds. European shares were also under pressure, despite receiving a boost from European parliament elections that returned a pro-European Union majority within the bloc. Elsewhere, UK Prime Minister Theresa May announced her resignation, leading to uncertainty about the ultimate outcome of Brexit.
But in the face of these issues, markets have been generally ploughing ahead in 2019 - after all the MSCI World NR Index is up 14.68% year-to-date. Elsewhere, the MSCI Europe and JP Morgan Global Government Bond indices have respectively delivered total returns of 13.14% and 4.16% over the same period.*
Lump sum or regular investing?
Our proprietary turbulence index tracks the evolution of parameters based on volatility and correlation - if the measure jumps sharply, it implies that the market is entering a risk-off mood.
During late 2018, investors endured a period of heavy volatility, with the index hitting 25, a level not reached since the days of the global financial crisis. However, throughout 2019 our index has been generally retreating, although May’s activity spurred on a slight increase.
At the beginning of the year, the index was hovering around 20, but by the end of May, it had fallen back to 8.6, and by mid-June it was pretty much at the same level.
Given the relatively benign market backdrop, more adventurous investors could be tempted to go all in. But in our view drip-feeding money into the market on a regular basis is a more sensible option, as it can help long-term investors to endure periods of market volatility.
Of course, you could invest a lump sum. By taking this route, it means your money will be put to work immediately, so you’ll benefit from any price increases. But equally, you’ll also be exposed to any downward movements, so if prices drop soon after you invest, your investment will fall in value too. For example, 2018 was something of a rollercoaster ride for investors, especially in the second half of the year – and anyone who had invested in global equities at the time would have quickly felt the brunt of the market falls during the July to December period.
However, by investing regularly, it means you don’t have to face the decision of working out exactly when you should invest. Instead your money will go into the market every month, regardless of whether prices are falling or rising.
The draw of pound-cost averaging
For those thinking long-term and investing regularly, volatility can even be a potential advantage. By drip-feeding money into the market, it means you potentially benefit from ‘pound-cost averaging’, which helps to smooth out investment returns over time, as this means you purchase more shares when prices are low, and less when they are expensive.
Therefore, over time, you’ll end up paying the average price during that period, helping smooth out market volatility.
For example, say you invested €100 a month over a 10-month period in a fund. If the portfolio’s unit price is €10 in the first month, your €100 investment would buy you 10 shares.
If the price dropped to €7 for the next five months, your same investment would buy you 14 shares in each of these months. If it subsequently rose to €12 for the remaining four months, the same €100 investment would only buy you eight shares in each of these months.
In total, you’d end up buying 112 shares over the 10-month period if you invested €100 a month. If, however, you’d invested a lump sum of €1,000 at the start of the 10-month period when the share price was €10, you’d have 100 shares.
Assuming the share price recovered to €10 at the end of the 10 months, your lump sum investment would still be worth €1,000, whereas if you’d invested regularly, your 112 shares would be worth €1,120, leaving you €120 better off.
Of course, the reverse could happen, and if share prices rose over the same period, your monthly investment would buy you fewer shares, leaving you worse off at the end. Whichever approach you take, bear in mind that no-one knows when the best time to invest will be - but committing to investing over the long term will give your money the best possible chance to grow.
Invest for the long term and stay diversified
While the backdrop – at least in terms of market returns – appears to be generally calm, at least for now, there are plenty of factors at play and without warning volatility could swiftly return. Consider too that asset classes tend to be more correlated during periods of market uncertainty, which only serves to add to the instability.
No asset class is going to win out all the time, so by diversifying across multiple asset classes and sources of potential investment returns it means you should hopefully be suitably prepared for any market wobbles, whenever they arise.
*Source: FactSet, data as at 13/06/2019
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