Investment Strategies that Cut Risks, Costs

By Datuk Noripah Kamso

 

If anything, most people are not saving nearly enough for retirement, so the focus should be on saving more, not less.

ARE you one of the lucky few who has plenty of money to invest but worries about stock market volatility? Or maybe, like most people, you don't have a lot of spare cash lying around to put in the market? In either situation, two strategies - ringgit-cost averaging and value averaging - could get your ringgit working for you with less risk and cost.

The basic idea behind ringgit-cost averaging is that instead of investing a sum of money all at once, you invest bit by bit regularly over a specific time. So, for example, if at the beginning of the year you have RM12,000 to invest in an equity unit trust fund, you may invest RM1,000 each month over the course of a year instead of investing it all at once.

This strategy helps you reduce risk because you're ultimately buying a selection of stocks (via a diversified fund) at a variety of prices throughout the year, instead of buying all these shares at a single price.

Value averaging works a bit differently. You first figure out how much money you need to accumulate for a certain goal, such as retirement. Then, based on the annualised return you expect to earn on certain investments, you work out how much you must invest each month to achieve the goal.

Each method requires different efforts and yields different results.

The ringgit-cost averaging and value averaging strategies do not provide magical formulas that simultaneously boost gains and lower volatility. Neither of them will give you any real control over the returns you earn. The markets largely determine that.

These methods give you a disciplined framework for saving. In addition, these strategies may lower the volatility of your portfolio somewhat, and more importantly, help you sleep at night.

Ringgit Cost Averaging
Ringgit-cost averaging is good for people who get frightened when the market drops after they invested a lump sum in it. They will feel better spreading out their investment over the year because it means regularly investing a fixed sum regardless of which way the stock market is moving.

When prices are high, the monthly investment buys fewer units, and when prices are low, the same amount of money buys more units. Over time, you will probably wind up with more shares at lower prices than if you buy them all at once. This method reduces your average share cost and spreads your investment risk over time. By putting money in a little at a time, you don't have to worry if the market is going up or down.

It is also simple to put this strategy into practice. Investors can do a simple standing order that transfers a monthly sum from their bank accounts into our unit trust funds. They can also obtain a CIMB Bank Credit Card through CIMB Wealth Advisors and conveniently charge their monthly investment on the card.

Value Averaging
Value averaging provides a much more systematic way of reaching a specified amount than regular ringgit-cost averaging. Since you are monitoring the value of your portfolio, you know right down to the ringgit whether you are on track and, if you are not, exactly what you need to do to get back on track.

For example, your goal is to accumulate RM500,000 over the next 20 years. If you believe you can earn an annualised return of eight per cent, then you would need to put away about RM875 a month. You can then chart your progress month by month towards that goal.

Here's where the "value" part of value averaging comes in. Let's say, at the end of the first year, instead of having the RM10,950 you should have to be on track toward your goal, a downturn in the markets leaves you with just RM10,000. That would mean that the next month, instead of investing your usual RM875, you would invest an additional RM950 to bring your portfolio's value to where it should have been, to remain on track towards your goal.

In fact, you would go through this process each month. In months where you fall behind, you would add to the amount you invest each month. In months where your returns are higher than expected and your portfolio's value gets beyond where it needs to be, you would scale back your monthly investment, or even possibly end up selling some units.

There are various ways to carry out this strategy. Instead of adjusting your investment amount each month, you could recalculate it every three or six months, even yearly. This is the essence of how value averaging works.

But like any system, value averaging has some drawbacks. If the market goes into a prolonged slump, or if you simply overestimate the potential return you can earn, you could end up having to make very large contributions to keep your account value on track. If you're not able to make these higher contributions, you may have to abandon your plan, or create a new one.

It also requires more discipline and efforts than ringgit-cost averaging. You will need to actively monitor your portfolio and re-adjust the amount you invest accordingly, to reach your goal. Unless you are highly motivated, it is likely you would need a financial planner or an adviser to help keep you on track.

Value averaging also requires that when everyone else panics, not only must you remain calm and continue to purchase stocks, you must also invest in far larger amounts than in calmer times. This is precisely why value investing works better than ringgit-cost averaging: It forces investors to buy more unit trust funds when prices are low than when they are high, increasing overall potential returns, on average.

Comparing the Two

Ringgit-cost averaging forces investors to spend a fixed dollar amount at regular intervals on a particular investment or portfolio, regardless of the unit price and time horizon.

However, value averaging is more ideal for investors who want to achieve their goals within a specific time. It is a formula-based investment technique where a mathematical formula is used to guide how much is invested into a portfolio over time.

While ringgit-cost averaging still works well, value averaging continues to outperform by producing generally higher potential returns.

According to Michael Edleson, author of Value Averaging, "Value averaging is about as close to 'buy low, sell high' as you can get without a crystal ball." I encourage you to read this book if you wish to find out how to put value averaging into practice.

Conclusion

The main benefit of both methods is they provide a disciplined framework for saving and taking advantage of the power of compounding interest, which could lower your portfolio volatility.

If anything, most people are not saving nearly enough for retirement, so the focus should be on saving more, not less. At the end of the day, the solution is to save as much as you reasonably can, regardless of what the market is doing. When you're investing for long-term goals, your ultimate aim is to reach those goals. And the more you save, the better the odds of you attaining that goal.

Datuk Noripah Kamso is the chief executive officer of CIMB-Principal Asset Management Bhd