Stock market lumps, bumps and buying on the dips

23 May 2018

To use a football analogy, 2018 has been a game of two halves so far. In January, markets barely batted an eyelid as global indices remained steady.

Then February’s inevitable market correction saw the UK FTSE 100 index and the global MSCI AC World index tumble. At the time of writing in late March, year to date, they have fallen by 5.85% and 7.42% respectively*. Volatility has returned with a bang.

This makes things tricky. Now that we’ve entered the new tax year, should we invest our money in one lump sum, do we add to our portfolios little and often, or should we buy into the market dips?

Some of us may have rushed to invest in lump sums a few days before the end of the tax year. Investing this way means that you immediately have a lot of money exposed to the market, which can be good or bad in the short term, depending on which way the market moves.

Others prefer to invest monthly. This means investors can benefit from pound cost averaging, which is when you end up buying more shares when prices are falling and fewer when they are rising.

This strategy reduces volatility, particularly when you first start saving and your pot of money is relatively small. As your portfolio grows, however, the impact of pound cost averaging reduces proportionately.

Another strategy is buying on the dips. This requires a stronger stomach, but volatility also throws up opportunities, so it can be rewarding.

“Buying on the dips requires a strong stomach”

The team at investment firm Rathbones has looked at how investors would have fared over the past 10 years if they’d have a) invested a £10,000 lump sum, b) saved £83 per month, also amounting to £10,000, and c) bought in the market dips (which, for the purpose of this study, means investing £500 on top of an initial £5,000 if the market falls more than 5% in a day).

The findings are shown in the table below.

As you can see, investors would have been best rewarded if they had bought in the dips, although their portfolio would have been volatile. They would have ended the 10-year time frame with a total of £20,739.38 having invested a total of £10,000.

Lump sum investors would have earned £17,711.78, having experienced a big drop in the value of their investments at the start of the decade.

Those who were dripfeeding £83 in per month would have earned £14,369.41 although, as mentioned above, with significantly less volatility than the other two methods.

In my view, it all comes down to individual investor preferences and availability of funds. I think it also depends on what you are investing in. For more volatile assets, such as emerging market equities, dripfeeding in may be less stressful than investing a lump sum. Because when this asset class falls, it can really fall.

For instance, the Elite Rated Lazard Emerging Markets fund – which can be particularly volatile because it also has a value bias – would have rewarded investors with £19,705.72 had they placed a lump sum of £10,000 into it a decade ago. However, they would have experienced a roller-coaster ride: the fund fell almost 40% at the start of the global financial crisis in 2008 but has since rebounded some 228%.

Return on investing styles

If they had dripfed £83 a month over this time frame instead, they would have had a remarkably smoother ride with only a 20% difference in returns.

Likewise, if you are investing in a lower-risk, multi-asset fund, lump sum investing may prove to be less of a bumpy ride and more rewarding over time.

A good example is the Elite Rated SVS Church House Tenax Absolute Return Strategies fund – the difference in returns is similar at 21%, but the difference in volatility between an invested lump sum and £83 per month dripfed over 10 years is minimal.

*Source: FE Analytics. Total return in sterling terms. Correct to 29 March 2018.

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Mr McDermott’s views are his own and do not constitute financial advice.

DARIUS McDERMOTT is managing director at Chelsea Financial Services and FundCalibre

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