There is a lot of chatter on the Web at the moment about the markets and the air beneath them. I can see in my own holdings that prices have risen but price to earnings multiples are also higher, which sadly means that they are not as safe as they were. At times like this it is tempting to shrewdly sell and wait for the next drop before swooping back in, thereby both pocketing extra shares for the same money and outsmarting one’s peers to boot.
I tried putting this plan into action when I first opened a trading account and discovered–to my cost–that trading was much more difficult than it looked. It calls for a rare combination of ice-cold blood allied with reserves of patience that would put a fly-fisherman to sleep. Having sold out and found yourself with a deposit of cash poised for redeployment, how do you know when is the right time to actually redeploy it? It is exceptionally difficult and, if you are encountering perfectly adequate looking opportunities while also watching the price of whatever you sold rise, highly frustrating. I now leave this to the professionals.
Instead, I think it is more practical to avoid lump sum investing by steadily drip-feeding a consistent and affordable amount into your investment account every month. This is usually described as pound cost averaging, which makes it sound more complicated than it actually is. The end result is that you get more shares when markets are low and fewer when they are high and, if you are disciplined in sticking to the plan, you avoid the conventional mistake most people make of rushing in to buy a portfolio of expensive shares when markets have risen only to panic and sell out after prices fall.
Of course, your returns would be much higher if you manage to sell at the top and buy at the bottom, but most people can’t do that. I certainly can’t. For me there are three compensating factors for putting up with the inevitable down years, corrections, and major sell-offs that come with the stock market:
- Dividends
Although prices fluctuate, dividends paid by good companies tend to keep rising regardless of market ups and downs. I think that a rising average monthly dividend income is decent compensation for a temporary drop in portfolio value. - Buying at the lows
If you buy shares every month then you are guaranteed to buy something, through sheer ignorant good luck, at what will prove to be at, or very close, to the market low. It will nice to look back on one of this purchases in the years to come and nod sagely, congratulating yourself on your exceptional perspicacity, buying when the blood was running in the streets etc. - Not having to worry about the overall market level
There are a lot of very clever people in finance and for every argument you encounter about the market being too high, there will be another for it being too low and both arguments are likely to be made by highly intelligent, persuasive sorts. However, one at most will be right and, in fact, both will often be wrong for a considerable period of time. It is enjoyable to disregard all such arguments and just look back on them after six months to marvel at how much nonsense was being spoken.
So, while the experts talk about what is likely for the next six months, I will keep plodding away by buying something every month and, although I will undoubtedly buy at numerous temporary highs, at some point I will also–entirely by accident–buy at a permanent low.