If you’re lucky enough to have a bit of surplus cash at the moment, it’s a difficult time to think about putting it to work. The easy option is to leave it in the bank, earning a modest (yet adequate) return and taking very little risk. That could be sensible in the short-term, but it’s not a long-term investment strategy. Cash and deposits offer no growth and very little inflation protection. Interest rates could also fall just as quickly as they’ve risen, should inflation keep slowing or we find ourselves in a mild recession.
You want your hard-earned capital working productively, which means you’ll find yourself in a common dilemma. It’s scary to think about venturing into financial markets (or any asset class, for that matter) with your savings. When things are going well, you wonder if you’ve missed the boat. When markets face challenges, it feels safer to wait for the outlook to improve.
One option is to simply close your eyes, grit your teeth and invest your hard-earned capital right now, all at once. While it sounds outlandish, empirical evidence proves this is a wise move. That’s because share markets are usually rising. I looked at returns over the past 50 years for shares in New Zealand, Australia and the United States. During that period, annual returns have averaged 9-10 per cent and markets were up in four out of five years.
Put another way, at any given time there’s almost an 80 per cent chance you’re better off just getting on with it immediately, rather than waiting around for a better opportunity.
Having said that, nobody wants to invest at the top of the market or when things are headed south. After all, the price you pay at the beginning has a significant influence on your future returns. That suggests you should sit back and wait for the downturn, then take advantage of cheaper prices. A great idea in theory, but this requires a fairly accurate crystal ball.
Markets have a habit of proving us wrong, and the long-heralded slumps we patiently await sometimes never arrive. There’s also the behavioural aspect of human nature to consider.
It’s easy to look back in hindsight and work out that the best times to invest is in the depths of recession and extreme negativity. However, during those periods we often aren’t brave enough to follow through.
Our inclination can be to wait until things are on the up, before making our move. We risk missing some of the rebound, and once prices have already moved we end up back at square one.
As with many things in life (and certainly when it comes to investing), being at extremes is risky. Diving in boots and all is imprudent, while waiting in the wings for perfect conditions can be equally unwise.
That’s why most investment advisers will recommend putting your money to work bit by bit. This approach is sometimes called dollar cost averaging or instalment investing.
The result will be a middle of the road outcome, but you’ll drastically reduce your chances of getting the timing completely wrong and ending up at the ugly end of the spectrum.
The investment backdrop always feels risky, no matter the conditions, but strategies like this can help swing the odds back in our favour.
Article written by Mark Lister, Investment Director at Craigs.