To invest or not to invest
As we approach bonfire night John looks at ways you can stay close to the fire without getting burnt.
Published on 29 October 2010
At our recent seminars in London a number of clients took the opportunity to speak to me, and although each of their circumstances were different, they faced the same problem and asked the same question…"should I invest my available cash now?"
These clients, and a number of others I have spoken to recently, have been sitting on the sidelines for some time believing that market levels were a bit too high and expecting a short term reversal, which would give them the opportunity to invest at levels they thought would offer "better value". The problem here of course is that this passive stance can cost the potential investor a lot of money.
The risk of being ‘in’ vs being ‘out’
If one uses the FTSE-100 as the yardstick this Index has climbed from a low of 3,500 points in March 2009 to over 5,600 at the time of writing, a rise of 60% (plus dividends) in less than 20 months. If you have stayed liquid you can take comfort from the fact that this growth would have been achieved only if you picked the absolute bottom of the market - possible only with more luck than judgement! However, do not get too comfortable, even over the last year the FTSE-100 has risen 12% with average dividends of over 3% to add to the mix…this would give you a total annual return of over 15% over the last 12 months compared to 2.5% - 2.7% if you had retained the money in an instant access savings account’ (source Money Supermarket/ Motley Fool comparison sites at the time of writing)
I think this clearly emphasises an important point for every long term investor who focuses on the very real risk of being in the market - an acceptance that there is also a risk of being out of it.
Be fearful whilst those around you are greedy…
There will always be reasons to be found to substantiate each side of the "invest or not to invest" debate but rarely more so than at present. Who can blame anyone for not investing when you look at the unemployment figures…1 in 10 in the USA and 1 in 5 in Spain? Or when you look at the growth in Government debt illustrated in the chart below. However, as detailed in my September Corner there are also at present some very strong tail winds to consider - current share valuations and earnings growth levels are both very positive.
(Source: Datastream, Barclays Wealth Strategy, OECD)
When I look back to 2003 I can see clear parallels with the situation today. Although the position was superficially very different, the problem was just the same. The FTSE-100 on the 1 January 2000 stood around 6,800 points and after falling almost continually over the next 27 months it was priced around 3,300 in March 2003. More people bought shares in January 2000 than they did in March 2003.The cheaper it got the less they bought! At times like this, more than any other, you should bear in mind the words of the legendary investor Warren Buffet when he said "be fearful whilst those around you are greedy and be greedy when those around you are fearful".
You may think these two comparisons are very different. After all during the Dot.com crash shares fell for over two years and today share prices have risen for about half that time. However, you do not have to have a falling market for it to be equally undervalued. Using the forward PEs as the measure, shares are now marginally cheaper than they were at the very bottom of the Dot. com crash back in March 2003!
Despite this, it would have taken a very foolhardy person to invest his or her life savings in March 2003. It is only now with the benefit of 20/20 hindsight we can see the full wisdom of doing this and the same statement could be made today.
In my opinion it is very simple. If you are a longer term investor as opposed to a trader, feed the money in slowly over time rather than sitting on the sidelines.
As I have already said it can be notoriously difficult to predict the bottom, or for that matter the top of the market however by feeding money in regularly over the longer term you could achieve lower average cost per investment unit through what is known as pound cost averaging.
Adding a little regular sparkle
Let me illustrate using a simple example. Instead of investing £2,000 in Company A in one lump sum you decide to be more cautious and initially invest £1,000 and hold the balance back.
You invest £1,000 in Company A at £1 per share. You were right to be cautious as the price of the shares falls to 50p and you decide to invest the balance of £1,000 at this price. The straight average would be 75p but the average price per share you purchased is actually 66.66p. Why? Because you will have bought in total 3,000 shares;
A much more detailed example, including details of the advantages and disadvantages, of pound cost averaging can be found here
in our Retirement Planning section.
Feeding money into the markets slowly over time is an ideal approach for a long-term investor to take especially when the future seems less than certain and especially so at times like this, when news flow is mostly negative but valuations of shares are generally cheap. It takes away the chance of getting your short term timing totally wrong, can reduce risk and allows you to focus on what a long-term investor should be concentrating on…what, not when to buy.
The value of investments can fall as well as rise and you get back less than you invested.
Good luck with your investments!
Page last updated 29 October 2010