Buy low, sell high. This is the fundamental principle one wants to employ in order to maximise capital gains on their investment. Many apply this principle only to stocks, but it is just as applicable to bonds and mutual funds. In each asset class (stocks, bonds & mutual funds), one should look to buy when prices are low or below perceived value and sell when prices are high or above perceived value.

When market conditions are stable, the buy low sell high principle works well. However, when market conditions become volatile it may be difficult to determine when asset prices are at their lowest levels or are at their highest.

Because of the volatility and unpredictability, we must employ strategies which will take us through the volatile times and allow us to position our investment portfolios for growth when stability returns to the markets.

One strategy to be employed is “dollar-cost averaging”. This strategy entails buying stocks, bonds or mutual funds at regular intervals with equal amounts of money. The intention is to buy over long periods of time in order to keep your average purchase cost as low as possible.

The first step is to determine a fixed amount to be invested and the frequency of the investments to be made (monthly, quarterly, etc). The second step is to select the investment or group of investments to be purchased and held for the medium to long term. Medium term being three to five years and long term five years or more.

Once the frequency and amount to be invested have been determined, the investment(s) should be made as planned regardless of market prices on the purchase dates. During times of price volatility, the investor will buy at a range of prices, both higher and lower than the initial purchase price. Ignore the price fluctuations and purchase the same dollar value of the asset(s) at the planned intervals.

When periodic purchases are combined, the lower prices will reduce the average cost per unit of the overall investment. A good example of this is an investment in a mutual fund which has fluctuated in market price per unit.

For this example, the investor makes an initial investment of US$1,000. As at January 2019 the unit price is at US$5.50. The strategy employed over the period is to invest an additional US$1,000 at the beginning of each quarter. As seen in the table below, the investor purchases at various prices over the investment period. Purchases were as low as US$5.20 and as high as US$6.00 over the period January 2019 to January 2020.

Over the period, US$5,000 was the total dollar value invested. The number of units purchased varied each month as prices fluctuated. At January 2, 2020, the investor owned 914.66 units with an average cost per unit of US$5.47 per unit. The market price on January 2, 2020 was US$6.00 per unit which gave the investor a total investment value of US$5,487.96. The gain in overall value of US$487.96 represented a return of 9.76 per cent.

The investor could have invested the US$5,000 as a lump sum at January 2019. In this example, the return would have 9.09 per cent on the lump sum if the investor bought at US$5.50 and sold at US$6.00.

The investor would be in a loss position if the market price per share remained below US$5.47. Using the dollar-cost averaging method, once the price rebounded above US$5.47 the investor was in a profit position. The lower average cost allows the investor to get back into a profit position more quickly when market prices are rising.

Dollar-cost averaging is a more reliable strategy, than trying to time the market, in order to obtain an average price per share that is favourable overall. A one-time investment of the US$5,000.00 would have exposed the investor to the risks of market volatility. With the unpredictability of the market prices as demonstrated in the example above, the investor could have mistimed the market and gone in when the market was at a high and may not have been able to recoup the principal invested.

Regardless of the investment amount, dollar-cost averaging is a long-term strategy. It is recommended that you keep your investments going through volatile times to see the real value of dollar-cost averaging. Over time, your assets will reflect both the premium prices and the discounted prices. The aim is to keep your average cost low. When prices are falling, buy units at cheaper prices to reduce average cost. When prices are rising, your average cost should be low enough to get you into a profit position more quickly than someone who invested a lump sum.

INVESTMENT ADVICE

In volatile market conditions, think long-term.

Use dollar-cost averaging to avoid mistiming the market.

Remove the emotion when investing.

Combine dollar-cost averaging with diversification, asset allocation and periodic rebalancing when managing your investment portfolio.

Dwayne Neil, MBA, BSc is the AVP, Personal Financial Planning at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm Feedback: if you wish to have Sterling address your investment questions in upcoming articles, e-mail us at info@sterlingasset.net.jm.