Montage Update and are there opportunities?

What a week?

There certainly has been a lot of interest in the current economic environment, which is hardly surprising considering that:

  • The global and NZ economies have been shaken by the impact of coronavirus, or Covid-19.

  • The Reserve Bank has cut the OCR to 0.25p.a. for the next 12 months.

  • The Government announced a relief package of $12.1 billion to support Kiwis.

  • The New Zealand dollar against the US dollar has dropped sharply to around 55 cents.

  • The share markets have been extremely volatile following the fallout from Covid -19.

  • Worldwide, Central banks are pumping money to the markets to make sure there is sufficient liquidity (money) in the banking system.

  • Crude oil prices dropped to around US $22 (had been around US $50 one mth ago)

  • Thus 19th Mar - NZ borders were closed to non-Kiwis.

Despite the above, it is important for all investors to maintain a long-term perspective as per our last email about ‘Time in the market is more important than timing the market’.

The following investment principle applies to current regular savings or new $’s (which can be drip fed) in a down or volatile market – called ‘Dollar Cost Averaging’.

Why dollar cost averaging is an opportunity

With dollar cost averaging, you take a lot of the emotion and fear out of investing because where the market goes in the short-term is far less important to you, as long as you stick to a regular savings plan. If a recession hits the economy and your investment falls in value, you’d just end up buying more shares at a lower price.

For example, let’s say at the beginning of this year, you put $100,000 all at once into a stock priced at $100 a share. By the end of the year, a recession or a dip in the market hits and the stock declines to $70, a 30% loss of $30,000.

Instead, what if you evenly distributed your money over the course of the year?

Let’s say you decide to invest $10,000 each month. When the stock is down, you end up purchasing more shares, and when it’s up, you purchase less shares. This increases the total number of shares you purchase and decreases your average share price.

In both good and bad economic times (as long as you can afford it), you should keep your regular (e.g. weekly, monthly, quarterly) contributions going into your funds.

Don’t be discouraged by the short to medium term drops in unit prices.

History shows that over time the markets recover and unit prices tend to be upward sloping.

Arun Abey (former Herald Reporter) published an interesting article on Dollar Cost Average based on an analysis conducted by MLC Australia in 1991 (after the Share Crash).

Here is the summary for the three scenarios:

Scenario 1

The graph A below shows what would happen in a situation where the market is increasing smoothly each year (Unit prices grow from $5 in the beginning to $10 after 10 years).

By investing $1,200 a year ($100 per month) over 10 years, your investment’s accumulated value would be $17,250 at the end of the period.

- a 43% increase on your total investment of $12,000 ($1,200 by 10 years).

Most might say that this is not a good reflection of what happens in the equity market. After all, we all know that it does not just always go up - occasionally there are some ‘downs’.

Scenario 2

Let us then have a look at what would happen in a more realistic world if you were to keep your investment at $1,200 a year or $100 a month.

If we look at graph B, you may be surprised to find that the accumulated value after 10 years is now $22,062.

- an 83% growth on your $12,000 total investment.

Note also that the year 0-unit value and year 10-unit value are the same as that used in the first case. How can we explain that?

The explanation lies in the fact that you end up buying more units each time that the market is ‘down’. At the end of the 10th year, you have more units valued at $10 than under graph A and therefore a greater accumulated value.

Scenario 3

In graph C the same concept applies as above, but with even more dramatic results. This time we are assuming that the unit price starts at $5, drops dramatically and then recovers to $5 after 10 years.

While the market is down, you are again benefiting by buying more of the ‘cheap’ units, ending with an accumulated value of $25,455 at the end of 10 years.

- 112% growth on your original investment.

So, it is clear that you need not be too scared of a depressed market or worry about short term drops in unit prices if you stick with ‘dollar cost averaging’ for your new monies. The more units you accumulate during the ‘lean’ times, the better.

‘Dollar Cost Averaging’ is an additional diversification technique. It enables you to diversify the timing of your entry into the market.

Continuing or even increasing your regular savings during challenging times is an opportunity to take advantage of falling or volatile markets.

Finally, without sounding flippant, markets eventually will recover, just as they did after the 1987 Share Crash, 1991 Oil Crisis, 2000 Crisis, and the 2008 GFC crisis, even though they all felt daunting whilst we were in the middle of them.

“In the middle of every difficulty lies opportunity.” Albert Einstein

Other Posts