Investing The averaging trick

When should I sow and when should I reap? This used to be a big issue for many farmers who lived in fear of the wind and weather. Some investors similar agonize over the best time to buy or sell securities.

It all looks so easy at first sight. You should buy securities when they are “cheap” and sell when they are “expensive.” The only thing is that, with equities and other investments whose prices fluctuate widely, this is difficult, as the winds can change direction quickly and without warning on the stock markets. Let assume that, early in the morning of October 19, 1987, you had invested 100,000 dollars in equities included in the famous US bellwether Dow Jones Industrial index. In just a few hours, your portfolio would have lost almost a quarter of its value in the ensuing crash, to be worth only 77,390 dollars.

Up and down in big steps

This extreme example of “Black Monday” shows how a few days and sometimes even hours can clinch success or failure for an investor. As a general rule, the worst and the best days on the stock markets lie pretty close together. A rapid fall is often followed by just as dramatic a rebound. The only problem is that such booms and busts, and hence the best time to buy or sell, are very hard to predict.

Fund company Fidelity did the math. People who missed the ten best days on the German stock market between 1990 and 2005 passed up half of the average annual return. And investors who missed the 40 best days would even have suffered a loss during the same period. Seen in this light, attempting to buy equities at the right time proves a risky move.

So is it a good idea to invest in the stock markets on any random day and hope that the value will increase in the long run? That would be a mistake, too. Although Swiss stocks have generated an average annual return of 8.4 percent over the last 60 years, there was no money at all to be made on them between 1998 and 2008. People who choose the worst possible time to start with equities sometimes have to wait for ages until they turn a profit. In other words, “cheap” stocks can remain cheap for a very long time, and even get even cheaper, before they rise again – and vice versa.

Strategy is crucial

According to the economists from UBS Wealth Management Research, this makes it all the more important to take strategic decisions: Are equities cheap or expensive at present? Do I want to hold equities or are they too risky for me? And how much of my wealth do I want to invest in them?

Once these questions have been answered, you should buy equities or appropriate equity funds and stick with them for the long run. The day on which you buy and which securities you select becomes less important. This is underscored by a study carried out by Gary Brinson, the founder of Brinson Partners, an investment company that has been incorporated into UBS. Brinson wanted to identify the factors in long-term investment success. To do so, he examined the investments made by institutional investors between 1974 and 1985. His findings: 94 percent of investment success was down to strategic decisions – like the decision on how to diversify across asset classes like equities and bonds.

Better to invest regularly

So would you like not to have to rely on the difficult, uncertain timing for your investment to be successful? But also not to invest all your wealth haphazardly at some random (probably wrong!) time? Then the best thing for you is to employ a tried-and-tested method: You invest regularly, possibly every month, and always the same amount. This means that the same amount is placed in securities every month. If their prices are high, the sum is enough for fewer securities. When prices fall, you automatically acquire a larger volume. This leads over longer periods to lower average buying prices – known in the trade as cost averaging.

Because time works in your favor in this case, you can stay calm when the mood swings on the financial markets. King Solomon took a similar line when he advised farmers that if they always watch the wind, they’ll never sow, and if they constantly look at the clouds, they’ll never reap.