 | An article written by Ray Calleja: Head – Private Clients, MeDirect |
Investing in a mutual fund may seem daunting and overwhelming at first. Instead of choosing just one company and one stock (one price, one ticker, one stock exchange, etc.), you suddenly need to look at long lists of different mutual funds. Before you get mired in those details, you need to decide whether you want some help choosing your funds or whether you would rather do it on your own. Like most choices in life, both paths have benefits and drawbacks.
Maybe you don’t have the time or interest to design your own mutual fund portfolio. If that is the case then speaking to one of our Financial Advisors at MeDirect is your next step. We can help you pull together a financial plan and a basket of funds that can help you achieve your goals.
The advantages of working with an advisor are clear: You have someone helping you make financial decisions, understand the fund and market performance, and making sure you are sticking to your important investment plans and goals.
There are costs involved, of course. But we feel that the Advisory service provided by MeDirect is very reasonably priced. As we discussed in previous articles, the Fund Manager of each Mutual Fund charges an annual management fee but a portion of this fee is paid back to the Bank by the Fund Management Company and on average this is 0.5% per annum on the value of the investment in the fund. The trading fee to buy into a fund is currently 0.75% of consideration, which again is a very competitive rate. There are no additional costs with MeDirect’s investment advisory service – no additional management or custody fees.
Those with the time and interest to learn about investing and to monitoring their own portfolios, can invest in funds without the help of an advisor. If you choose to invest on your own, then you can use the MeDirect online trading platform to invest in mutual funds from a very large selection of almost 550 funds. The online fee to buy into mutual funds at MeDirect is just 0.5% of consideration and you can invest as little as a few hundred euros, which is particularly useful and attractive if you want to invest a regular monthly or quarterly amount to build up your nest egg.
New investors who plan to buy more than one fund might choose one of the larger fund houses, mainly because these fund houses are diversified, since they offer equity and bond funds, US and international funds, and large- and small-company funds. Most fund investors eventually own more than one fund because of the need for diversification.
This brings us back to the decision of whether to use a financial advisor or to go it alone. More choice often leads to lesser ability to make good decisions and investors can make the classic mistake of spending too much precious time on their finances when they could be spending it on higher priorities, such as family, health or personal goals.
There is also a significant aspect that investors need to take into account in the do-it-yourself path: Money is one of the most emotion-provoking things on earth. You must be able to avoid your worst enemy – yourself by not succumbing to the normal and damaging emotions of greed, fear, complacency and over-confidence. An investment advisor or financial planner can think about your money with little or no emotion but you may not be able to separate the two.
A good financial advisor will look at your money logically and help lay out an objective road map to follow so you can reach your future financial goals while living your present life more fully.
Having decided whether to invest with the help of an advisor or not, the next step would normally be how much and when. If you have money to invest, you will need to choose one of the following approaches:
1. Wait until you believe it is the right time to invest your sum or
2. Invest the entire amount immediately or
3. Put a little bit to work at a time
You should be aware that the route you choose can have a profound impact on your total return.
Trying to Time your Investment
Holding off on an investment until you sense the time is right is one option. That can mean when the fund’s performance falls, when it rises etc. Such a strategy is often called market-timing.
As you can probably sense, we as a bank are not keen on market-timing. Evidence suggests that it just doesn’t work. Predicting the future has never been easy, and this can happen with anything in life not just investing. Studies from our investing partners Morningstar have shown that investors’ timing often leaves something to be desired – they buy in when a fund is ready to cool off and sell when its performance is ready to pick up. And that can be so true especially at this time of so much high volatility during this corona virus pandemic.
In an experiment conducted by Morningstar that went back 20 years and assumed that in each quarter, an investor chose to own all stocks (represented by the S&P 500) or all cash (in their experiment, Treasury bills – equivalent in our case to Government stocks). A market-timer who picked the better performer half the time still ended up way behind the market after two decades. Morningstar found that not until the timer’s hit rate reached 65% did he beat the S&P 500. In other words, the market-timer had to be right two out of three times to justify the effort.
This is largely because over time, the stock market has notched higher gains than holding cash. Botching a market-timing decision usually means sacrificing good performance. Worse still, missing a period of strong returns means giving up the chance to make even more on those gains, thanks to the effects of compounding. That is, each year you earn returns on the returns you earned in prior years, as well as on your initial investment.
Lump-Sum Investing
If market-timing is a losing strategy, what about the opposite: putting all the money to work at once? Many financial advisors recommend this approach above the others, because the market goes up more often than it goes down.
Here’s an example. Say Investor A decides to invest an amount of €12,000 all at once in one fund while Investor B, who also happens to have €12,000 to invest, instead places roughly €2,000 per month in the same fund over the next six months. The fund consistently rises in value during that time. The chart below illustrates what would happen to the two investments.
Investor A ends up ahead, because he owns more shares at the end of the six-month period. And he owns more because, due to the consistently rising value of the fund, Investor B could not afford to purchase as many shares as Investor A had purchased originally. But what happens if the value of the fund fluctuates dramatically during those six months?
In this case, Investor B ends up in the lead. By investing a fixed dollar amount in the fund every month, Investor B bought more shares when the price was low, fewer shares when the price was high, and ended up with more shares after six months. So, he ended up with 6,224 shares against the 6,000 shares of Investor A.
Such drastic fluctuations in NAV are rare. Because the stock market generally goes up more often than it goes down, most investors will receive the best long-term results by lump-sum investing.
Cost Averaging
However, there are many investors who feel emotionally much calmer by investing at regular intervals. In the US, this is called Dollar-Cost Averaging (or DCA). Not only might this investment strategy be an effective way to grow your portfolio over time; it can also be a prudent way to navigate the complex and often nerve-racking conditions of a stormy economy, such as the one we are living now during this pandemic. DCA investing as a matter of principle and habit can help you eliminate a lot of emotional trouble – thinking about whether to invest, how much to invest, whether to stay out, and when to get back in.
Investing in small sporadic amounts may not be the path to greater return, but we still think that cost averaging, or investing a set amount on a regular basis, is a great method of investing. As we explained, cost averaging can reduce risk. If your mutual fund declines in value, the worth of your investment is less, even though you still own the same number of shares. In the same way that cost averaging will net you more shares in a declining market, it can curtail your losses as the fund goes down. The chart below illustrates this point.
In this example, both Investor A and Investor B lost money (remember, they each started with €12,000), but Investor B lost less by cost averaging. Investor B kept the cash sitting on the sidelines and when the fund rebounds, Investor B also will be in better shape because he owns more shares of the fund than Investor A.
The second reason we are in favour of cost averaging is that it instills discipline. Investors often chase past returns, buying funds after a hot performance streak. And they will sell funds when returns slow down or decline. That is a bad idea and it is just like trying to time the market. Cost averaging prevents you from doing that because you are buying all the time.
Our conclusion is that while market-timing is not ideal (but some still try it), whether you invest all at once or a little at a time, depends on how much time you have to invest and whether your primary goal is maximizing return or minimizing risk.
The shorter your time horizon, the greater chance you take of losing money with a lump-sum investment. However, if you had €50,000 to invest, it probably would not make much sense to invest €2,000 per year for the next 25 years! Over long-time frames, funds go up more often than they go down, and when they go down, they eventually bounce back. It is almost certain that the NAV you would pay 10 years from now would be higher than the NAV you would pay today.
Therefore, one may consider combining the two strategies: Invest as much as you can today and vow to invest a little more each month or every quarter.
The above is for informative purposes only and should not be construed as an offer to sell or solicitation of an offer to subscribe for or purchase any investment. The information provided is subject to change without notice and does not constitute investment advice. MeDirect Bank (Malta) plc has based this document on information obtained from sources it believes to be reliable but which have not been independently verified and therefore does not provide any guarantees, representations or warranties.
MeDirect Bank (Malta) plc, company registration number C34125, is licensed by the Malta Financial Services Authority under the Banking Act (Cap. 371) and the Investment Services Act (Cap. 370).
The financial instruments discussed may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.
If you invest in any of the products discussed you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment and may be deducted from the invested amount therefore lowering the size of your investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.
