Tuesday, 15 October 2019
Written by Matthew Stuart-Box, COO, Head of Investment Platform
MYTHEO has a Regular Savings Plan service so that customers can automatically invest a regular amount each month. This is a great way to get started with investing and, at MYTHEO, you can set up monthly regular savings with as low as RM100 per month.
Investing a small, regular amount each month may not seem like a huge investment but did you know that it is actually a very important way of diversifying your investments over time?
What are the basics of investing?
Two key investment concepts are “diversification” and investing for “long-term”.
There are various kinds of diversification, such as by “Region” i.e. investing in a range of countries, “Asset Class” i.e. investing in a range of different types of assets and “Time”. Regular Savings are useful for “diversification over time”.
What is “diversification over time”?
When we look at financial news, we see the prices of financial assets changing every day, e.g. “Dow-Jones has risen 5%” or “Long-term bond prices have fallen in the New York Bond Market”. Since they are always moving, no one knows when prices are high or low.
Financial markets are said to have cycles or periodic fluctuations. Firstly, there are long-term changes due to changes in society or technology. Secondly, there are medium-term fluctuations associated with the “economic cycle”. The economic cycle is the idea that the economy repeats the four states of boom, bust, recession and recovery in order, with good times following bad times. There are also short-term fluctuations driven by changes in supply and demand as well as large, sudden shocks like the Global Financial Crisis (GFC), in other words known as the ‘Lehman shock’.
Malaysia enjoyed rapid economic growth in the 1980s and 1990s due to rapid industrialization and a strong inflow of foreign investments. Malaysian stock market experienced a superbull run which began in 1993 before it was halted by the infamous Asian financial crisis in 1998.
Post-1998, the Malaysian economy recorded a strong recovery mainly due to the tight capital control and a restriction on Ringgit which was pegged at RM3.80 against US Dollar. However, in 2001, the Malaysian stock market suffered a minor setback after the collapse of the tech bubble.
Post the tech bubble, the Malaysian economy benefited from the spillover of strong economic growth in China. From 2001 to 2007, strong demands for commodities led to the multi-year rally in crude oil and palm oil prices that provided strong support to the economic growth and stock market performance. But the long cycle ended with the Global Financial Crisis (GFC) in 2008. It is clear that there have been cycles of growth and recession in the Malaysian market.
Given these cycles, what would have happened if you bought when the market was high and sold it when it was cheap? It would be a very inefficient and an unprofitable way of investing.
How can risk be reduced by diversification over time?
Risk from price fluctuations can be reduced by investing in multiple steps rather than all at the same time.
For example, let’s say you have $200 to invest. If the price of the security that you want to buy is $100 in the first month, you can buy two shares. If the price of this security drops to $50 the following month, your total assets will be worth $100 and the value of your portfolio will have halved.
On the other hand, suppose you divided your cash in half and invested $100 each month. You can buy 1 share for $100 in the first month and 2 shares with the remaining $100 in the following month. In this case, the value of your assets at the end of the second month is $150 instead of the $100 that you would have had if you had invested all of your cash at the start. In this way, by spreading your investments out over time, you can greatly reduce the risk of buying when prices are high.
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Spreading your investments over time and investing the same amount on a regular basis is called “dollar cost average method” and it is a popular way of investing. Under this approach, even if the price of a financial product fluctuates, we invest the same amount into it at regular intervals.
As explained above, if you invest same amount each month, even though the price might be high one month or low the next, by continuing to purchase at a constant amount for a long time, you can invest in the security at its average price.
But investors are emotional creatures. You may be distracted by the ups and downs of the market, and you may try to increase, decrease or even stop investing in reaction to these movements. In other words, you may try to “time the market”. This can be profitable if you are able to predict when the price is likely to rise or fall but this is very difficult to do consistently. Indeed, this approach of trying to “time” the market may be counter-productive in the long run since, even if you think "prices may get cheaper" or "prices may go higher", you won’t know for sure until after prices have moved.
This is where investing a fixed amount at regular intervals comes into play. By automatically investing a certain amount of money on a fixed date every month, you can take action automatically without being influenced by emotions caused by rising or falling prices.
Some people may want to invest at their own timing and of course, it is good to invest at any time. However, why not use MYTHEO’s Regular Savings Plan to reduce risk by diversifying your investments over time?
Malkiel, B.G. 1996. "A Random Walk down Wall Street: The Best Investment Advice for the New Century", W.W.Norton&Co., New York.Vanguard. 2012. "Dollar - cost averaging just means taking risk later", Vanguard Research.