This year, the Malaysian stock market hit its lowest level in 11 years amid coronavirus fears, then surged the following month. Overseas, the US stock market hit an all-time high, experienced its steepest decline, and then rebounded – and that was only in the first six months.
As an investor, it can be difficult to see your portfolio go through these extreme highs and lows. It can also cause you to question your investment strategy – you’ve always been told to invest as early as possible for retirement, but how do you invest in uncertain market conditions?
The wrong way to invest
First let’s see how you should not invest.
However, he watched his portfolio with concern as it suffered losses in 2019. When the stock market fell sharply in February and March of this year due to fears of COVID-19, he panicked. Fearing that the stock market would continue to decline, he sold his portfolio to cut his losses.
Soon after, the stock market started to rise again. At first, Johari was not sure whether to redeem, as we were still in the midst of the coronavirus pandemic. But when the stock market continued to rise, he didn’t want to miss – so he bought back into the stocks he had previously sold.
In the example above, Johari invests depending on whether he thinks the stock market will go up or down. But this is risky and can lead to investment losses.
What’s wrong with the timing of the market?
Investment-based predictions of stock market movements – known as market timing – don’t work for most investors. Here’s why:
- The stock market is difficult to predict. Investing based on how you think the stock market will go is risky because it is so hard to predict. There are many factors at play, including company valuations, economic growth, interest rates, political stability and investor confidence. Right now, things are even more uncertain as we grapple with the economic effects of the coronavirus pandemic and ongoing trade disputes between China and the United States.
- Buying down can still result in losses. Over the long term, the stock markets tend to trend up. So even if you could predict when the stock market will bottom out, waiting to buy the bottom could cause you to miss out on gains in the meantime.
- Emotions make us irrational. When your hard-earned money is at stake, emotions can keep you from deciding when to buy or when to sell. Fear prompts people to sell when stock prices fall, and greed prompts people to buy when prices rise again – but buying high and selling low is not a great investment strategy.
That’s not to say that the timing of the market never works. Some investors use stock valuation metrics or technical indicators to determine whether to buy or sell. But it does require discipline and advanced investment knowledge. And since the market is unpredictable, even the big market specialists can be wrong.
Here’s where the average dollar cost comes in
If the market’s timing isn’t working, what does it do? The answer is dollar cost averaging strategy.
The dollar cost averaging strategy is to invest a fixed amount of money on a fixed schedule (for example, monthly or quarterly). It doesn’t matter if the stock market is going up or down, you just need to stick to the schedule.
Here’s why the dollar cost average works:
- Avoid entering the market at the wrong time. By spreading your investments over time, you will minimize the risk of investing all your money when prices are at an all time high.
- Avoid investments based on emotions. By investing a fixed amount on a schedule, the average dollar cost prevents you from making emotional adjustments to your investment strategy.
This can be a powerful approach when the stock market is going down. It helps you invest when prices are low, when other investors may stay away out of fear. This prepares you for bigger gains when stock prices recover.
Lump sum investment versus average dollar costs
How does lump sum investing (i.e. investing all of your money at once) compare to average dollar costs during a volatile market? Let’s compare investing a lump sum of RM 10,000 in fund A, versus investing a quarterly sum of RM 2,500 in the same fund.
Comparison of lump sum investment and average dollar costs. Figures are indicative only
In this example, you invested at an inopportune time, just before the price of Fund A started to fall continuously. However, its price increases in the last quarter of the year.
With the average cost in dollars, you will be able to invest in more units when its price drops. When its price recovers, you will have a larger capital gain. For example:
What would your capital gain be if fund A were RM1.50?
|Lump sum investment||Average cost in dollars|
|Investment cost||10,000 RM||10,000 RM|
|Units Purchased||10,000||11 875|
(RM1.50 x number of units)
|15,000 RM||17,813 RM|
(Portfolio value – investment cost)
As such, the dollar cost averaging strategy can help minimize risk when markets are volatile or declining.
Focus on the long term and your long term investment goals
When you practice averaging dollar costs, don’t be swayed by short-term market movements. The stock market will fluctuate from year to year, and it could face crashes and booms. By continuing to invest for many years, you will have a better chance of overcoming these volatilities to earn positive returns. It is also helpful to remember what you are investing for, such as your retirement.
Invest in funds, not individual stocks
However, even the average dollar cost cannot save your portfolio if you pick the wrong stocks. This is why it is extremely important to do your own research before investing. If you are unsure about choosing the right individual stocks, consider investing in unit trust funds. This allows you to diversify your portfolio and spread your risk over many types of investments. You can even use your EPF savings to invest, you can diversify your savings without withdrawing additional money.
Today, diversifying your retirement savings has never been easier. The Employee Provident Fund (EPF) recently reduced its initial costs for its online investment platform, EPF i-Invest, at a subscription charge of 0%. The fee reduction is valid until April 30, 2021. This means that you will not have to pay an upfront fee for the average dollar costs in Unit Trust Funds.
But which funds should you consider?
Primary asset management (Principal) has a range of unit trust funds approved by the EPF to meet different risk profiles:
All investments involve risk. Visit www.principal.com.my to access the prospectus of these mutual funds, the reference sheets and the annual reports for more information on the risks involved.
On the occasion of the first anniversary of the launch of Principal EPF i-Invest, Principal rewards all EPF i-Invest investors by September 9, 2020. Invest a minimum of RM2,000 to be eligible for a Touch ‘top-up’ n Go pin:
Click here for campaign details, terms and conditions.
With unit trust funds and a dollar cost averaging strategy, you’ll be able to minimize your investment risk during these volatile times – to maximize your chances of a comfortable retirement.
Follow the steps below to take charge of your retirement portfolio and be rewarded.
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