RAND COST AVERAGING THROUGH MARKET CYCLES USING REGULAR MONTHLY CONTRIBUTIONS
One of the large local asset managers use the word “consistency” as their premise. Doing the right thing over and over will deliver your best investment outcomes. Successful wealth creation is often about doing things that may feel difficult at the time, especially when markets are retreating – it feels like you are throwing good money after bad. In this month’s Financial View, we look at the concept of Rand Cost Averaging and why low share prices through negative market moves create the opportunity to take advantage of a discount.
Rand Cost Averaging
Rand cost averaging is the practice of making regular recurring monthly contributions towards an investment instead of investing irregular lump sum amounts. Consistency is the key because when the markets are down, such as now, you end up purchasing more units. We often cite the example that if Mercedes Benz was selling their cars at a 20% discount, then everyone would be driving a Merc. A 20% drawdown in the markets has everyone running for the hills (or switching equity investments into cash) which is the exact opposite of what they should be doing – which is to take advantage of lower prices to accelerate the building of their investment portfolio.
Rand Cost Averaging in practice
We have used the share price of Anglo American to demonstrate how Rand cost averaging works in practice. Anglo American is a company well known to most of our readers, and as a general diversified miner their business tends to be cyclical and linked to the movements of the commodities prices.
The share price of Anglo American is volatile and represents a typical cyclical business. The super commodity cycle of mid 2000’s benefited Anglo American before the total collapse following the Global Financial Crisis. Anglo American have also recently benefited from recent turmoil in the world as commodity prices have risen due to supply constraints as a result of sanctions imposed on Russia.
If one invested each month in Anglo American, you have benefited from the drop in the share price enabling you to pick up more shares at some compelling discounts. The share price in the low of 2016 was a lowly R55 a share. For R1 000 investment you could have purchased 18 shares. Those 18 shares would be worth over R10 000 in today’s money. A close to 10x return in just 6 years often referred to as a ten bagger in market terms.
If the investor had invested R1 000 per month each month since January 1994 in Anglo American, they would have invested R342 000 in total and be the owner of 2 389 shares of Anglo American. The value of the portfolio as a return on the R342 000 invested is R1.39m. The investor has 4 times the amount of money that they originally invested just by being consistent. This return excludes dividends which would have further enhanced the returns.
The reason Rand cost averaging works is that it removes emotions from the investment decisions. Just because the Anglo American share price collapsed late 2015 it didn’t cause the investor to flee – and it allowed the investor to buy more shares at a good price, resulting in the investor getting more bang for their investment buck.
Conclusion
Generating wealth is not easy, often our emotions tend to cause us to make decisions that are contrary to best practice. Warren Buffett famously said that one should be fearful when others are greedy, and greedy when others are fearful. In other words, buy when prices are low and be wary when pricing is high. During market down turns, when the value of your investment is reducing this is not the time to panic and sell. It feels like the more you buy the more your end value reduces, however this is often the best time to buy as you are buying good value. It’s during these times the purchases that you make often generate the best returns. Through the application of consistency one can take comfort that no opportunity, and no discount is missed.
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