May 12, 2020

How to invest on the ‘drip’ – Euro Cost averaging

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With the hard lessons of market volatility and major falls from post Lehman’s fallout deeply entrenched in people’s minds it’s not hard to see why there is still so much money locked up in deposit accounts or even tracker bonds. Low risk or no risk is the name of the game, or so it seems.

As someone whse experience in markets dates back to before Black Monday in 1987 I am continually mystified why investors fail to learn from history. At that time the Dow Jones fell 24% in one day only to recover in full 18 months later. The market has since gone on to grow by a further xx% despite the defaults by Argentina and Russia, two wars in Iraq and one in Afghanistan, the LTCM crisis, the bursting of the Tech bubble and not forgetting the current Euro crisis. Even since the recent low of 9th March 2009, the markets have grown by xx%. Any investor attracting a 12 month ECB deposit rate would only have got xx%. Inflation meanwhile has been running at xx% over the same period.

While the markets can be intimidating, which is only natural for low-risk investors, it is important that investors realise that the risks of being out of the markets are greater than the risks of being in them. Yet few would be brave enough to invest in full, hence the large hoardings of cash that currently exists.

There is a solution however! Rather than commit a large lump sum or even the whole portfolio to the vagaries of the stock market in one go, one can instead invest on the drip through a strategy termed Euro Cost Averaging. This consists of investing in equal amounts over a given period – it may be weeks, months or even a year. This is different to the regular investing in a pension scheme or a savings plan through which an individual makes regular monthly contributions. 

While academic papers have been published which have been relatively unchallenged that show Euro Cost Averaging does not provide optimal investment returns, it does, however, perform a valid function for queasy investors. Whether such individuals have funds to invest as a result of the sale of a business, a retirement tax free lump sum or an inheritance all would like their money to work best for them. Good investment isn’t just about optimising returns it’s also about peace of mind at night.

Thoughts abound of  “What happens if I invest all this money, and the stock market drops?” This then leads to procrastination and the impossible waiting to see what the market does before you invest. The mere thought of possibly investing in full and then seeing the market fall significantly in the days or weeks that follow would prompt further feelings of “If only I waited a little longer”

Euro Cost Averaging is probably best described as an emotional insurance policy that provides cover against a large sudden drop right after you invest your money. In practice, it involves investing a specific percentage of your lump sum at regular intervals over a given period until it is all fully invested. For example, it might take the approach of investing one-sixth  of your original sum on the first day of every month for six months.

So if you think that Euro Cost Averaging will help you deal with the emotional risk of investing, go ahead and do it. There are a few things, however, to bear in mind:

1. Do it quickly (or relatively anyway). Invest the money over six months or less as evidence shows that six months or less accomplishes the emotional benefit such individuals are looking for. It also ensures that you do not stay out of the market for too long.

2. Follow the script! Make a plan on the investing timetable and stick to it, no matter what markets might do. The second you start reacting to markets is the second when you start becoming undone.

Otherwise, keep your money in cash as all that will happen is further loss of funds as you try to outguess the markets!

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