Whatever your financial planner tells you, you need a saving and investment strategy to force you to be fearful when others are greedy, and greedy when they are fearful.
Whatever your financial planner tells you, you need a saving and investment strategy to force you to be fearful when others are greedy, and greedy when they are fearful.
Because without it, it’s virtually impossible to buy shares when you should. That is the role of an investment technique called dollar cost averaging, and you should be using it now.
What is dollar cost averaging? To paraphrase Wikipedia: “The idea is simple; spend a fixed dollar amount at regular intervals on a portfolio or part of a portfolio, regardless of share prices. In this way, more shares are purchased when prices are low and fewer shares are bought when prices are high. The premise of dollar cost averaging is that the investor wants to guard against the market losing value shortly after making his investment. Therefore, he chooses to spread his investment over a number of periods.”
To effectively organise your dollar cost averaging you need to work out how much money you have to invest in equities and, therefore, think through your asset allocation program. There is a series of very complicated ways to do this, but they all end up sacrificing the ease of implementation that you can get by following these simple steps.
First, work out how much you have available for investment today plus how much you are proposing to add by saving over the next three years. That gives you a total amount available for investment.
The next step is to work out how much you already have in equities today, which is the sum of your share portfolio plus your equities in superannuation. The super equities allocation is the amount of your super account multiplied by the equity allocation of the fund you have chosen; balanced, conservative or aggressive – each have different allocations and you can find it from the fund’s annual report.
You then divide the equities you have today by the total of all the savings you will have in three years to get a starting percentage equity allocation. For a simple example, let’s assume you have a portfolio of $100,000 today of which $50,000 is in shares and you expect to save $50,000 over the next three years.
If you assume nothing changes in three years you will have a 33% equity allocation: $50,000/$150,000. Is that enough, too little, or too much? There are a number of ways to calculate this, but the tried and true method is by way of a lifecycle asset allocation model, which takes account of the fact that your risk appetite should start very high when you are young so you can get the best returns possible and decline over your life as you approach a time when you need certainty more than higher returns.
The traditional views from a lifecycle asset allocation model are that you should have a percentage that equates to “100 minus your age” as your equity exposure. My view is that the number is too conservative and that the percentage should be closer to 120 minus your age, with an adjustment at retirement if you are fully covered for your needs. If you are interested in the various alternatives for how to calculate your equity exposure, just Google “lifecycle investing”.
If you are 37 and use my approach, in three years (when you are 40) you will need 80% equities exposure. Hence, if you have only 33% of your money in equities now, you are 47% underweight equities, or you have $70,500 to invest in the sharemarket over the next three years. Divide the $70,500 into 12 equal instalments of $5875. You have to invest that amount each quarter without fail.
To make the game a bit more interesting, I try to pick a low point in the quarter – but I know I can’t procrastinate beyond a certain day. If I’m still not invested by then, the money goes in automatically.
Yes, it hurts to invest in this market and yes, I am losing money. But the tide will turn, and without a forced savings plan I will be looking to play catch-up after the next bull market has well and truly started.
The best informed of the investment thinkers, people like Jeremy Grantham and Noreil Rubini, say the bottom of this bear market is still 10% to 20%, and six to 24 months, away. I agree with them, yet every quarter I keep making share purchases. Of course I am down on the ones I’ve made over the past year, but I know I am not smart enough to pick the bottom, and over the long term shares always outperform all other asset classes.
Remember the old truth: The bulls have been winning for 500 years. Start dollar cost averaging now.
Mark Carnegie is a principal of the corporate advisory and private equity firm Lazard Carnegie Wylie. He is also a part-owner of Australian Independent Business Media, which publishes Eureka Report.
This article first appeared in Eureka Report
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