A SUCCESSFUL STRATEGY FOR INVESTING IN VOLATILE MARKETS

Many investors have experienced the high volatility of share markets over the last few years. Others may simply be scared to invest in shares because of market volatility.  It seems opportune to recap on an important investment strategy for long term investors, particularly regular savers.

The strategy is simple. It is called dollar cost averaging, which can work very well for savers. Many investors, if not all of us at some time, are influenced by our hearts rather than our heads when it comes to making investment decisions. Sentiment is a very powerful force that swings between exuberance and despair.

Bull markets often start when the background news may seem dire, but this is not always the case. During the 1929-1931 crash, the US market rallied by 60% from its initial 45% sell off in 1929 before finishing up almost 90% below its peak. The initial rally was misplaced, with the Great Depression lasting another eight years.

To most people, this sounds scary. Even during this period, market sentiment moved up and down dramatically. The Dow Jones index fell 50% in 1931, rose 60% in 1933, and by 40% in 1935, but fell 30% again in 1937.

We can overcome the problem of dealing with volatile markets by making use of Dollar Cost Averaging. This is simply investing equal dollar amounts at regular intervals. This approach dispenses with the need to worry about market uncertainty and volatility. The way it works is that more shares are automatically purchased when the price is low and fewer when the price is higher.  With this approach it is important to make sure that your purchases are of sufficient size to minimise the impact of transaction costs.

Even over the period of the 1930’s Great Depression, this strategy would have proved rewarding despite the fact that the Dow Jones Index did not close above its 1929 high of 381.17 until November 1954! If, at the end of each year between 1928 and 1939 a constant amount was invested, by the end of 1939 there would have been a 25% profit!

Experience shows that if share prices fall, some investors panic and decide not to continue buying.  These same people will do the opposite, when a store has a sale.  They will take every opportunity to buy sale goods, yet at the same time when shares are on sale and the bargains are to be had, the long term savings plan seems to go on hold. 

Stick to a strategy and avoid knee jerk reactions to short term market movements. That is, do not try and second guess where the markets are heading. Acting on fear and greed impulses can result in buying at the top and selling at the bottom, often with disastrous financial results. This applies to all investments including property.