Why Invest Regularly: Part One
A Regular Saving Plan (RSP) is a simple savings strategy that avoids having to time the market. Instead, it uses the natural cycles of the market to help investors grow their long-term wealth.
In Part One of our RSP series, we show how regular investing can lower the risk of losses in declining markets.
There are many reasons to invest regularly. One of the most obvious is that it imposes a discipline on individuals to set aside part of their income every month for investing purposes.
However, there is another benefit to RSPs. By drip-feeding money into your portfolio on a regular basis, you are actually able to reduce your investment risk when markets are weak. Here is how it works:
1. You can benefit from dollar cost averaging
Dollar cost averaging is the technique of buying more units when prices are low and fewer units when prices are high. Regular and consistent investing helps you to apply this technique.
Let’s say you have a RSP that invests $1000 a month into your chosen portfolio.
|Capital Invested ($)
||Unit Price ($)
||No. of Units Purchased|
|Average Cost per unit2 ($)||$109.49|
On the first month of your investment, the unit price of the portfolio was $250, so you were able to purchase four units. In the event that the market continues to perform poorly, and the unit price continues to fall, you are able to purchase more units every month for the same $1,000 investment.
By the end of five months, you would have acquired 45.67 units for $5,000 and your average cost per unit is $109.49. In contrast, if you had invested $5,000 as a lump sum in the first month, you would have only acquired 20 units at a cost of $250 per unit.
2. You can focus on your investment objectives rather than timing the market
Every investor would love to buy at the trough and sell at the peak of the market with perfect hindsight. But in reality, it is extremely difficult to do so. Instead of sitting on the sidelines and waiting for the right time to enter the market, an RSP means you remain invested in all market conditions.
This frees investors from becoming distracted by market movements, RSPs give investors the space to consider not “when to invest” but “what to invest” in order to meet their investment goals. By making realistic assumptions about the average cost per unit and potential returns for a selected portfolio, investors are better able to assess the risks and time horizon required for achieving specific investment targets.
3. You reduce the likelihood of making a poor decision due to human emotions
As humans, we are all subject to emotional investing. As a result, we are often tempted to enter a market just when it is starting to peak, or panic sell an investment just when it is reaching the bottom. As experts have long noted, emotions like fear and greed tend to get in the way of sound company fundamentals and economic projections.
By subscribing to an RSP, money is systematically allocated to your portfolio in both rising and falling markets. This helps remove the emotion from investing, which then allows you to benefit from a market’s long term trend, rather than be swayed by short term corrections.
Risks: RSPs can underperform lumpsum investing in steadily rising markets
It should be noted that regular investing will underperform a lumpsum investment should you manage to buy into a portfolio or mutual fund that is moving up steadily.
This is because a lumpsum investment at the start of a rising market cycle means that you are already fully invested and can therefore take full advantage of the uptrend in prices. With an RSP, your fixed monthly investment means you are acquiring fewer units every month as units become more expensive.
RSPs are a long term risk management tool
RSPs are a way to stay invested in markets that are expected to strengthen over the long term, but can experience extended periods of weakness. In such scenarios, your RSP ensures that you do not miss out on positive market movements, but helps to limit the worst effects of price falls. As such RSPs act as an effective risk management tool.
In Part Two, we look at how RSPs perform in highly volatile versus less volatile markets. Read more - A defensive approach to investing.
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