05/04/2016

The degree of sharemarket volatility during the first three months of the year will regrettably have thrown some investors off their long-term course.

Let’s briefly recap by looking at the broad S&P/ASX 300. The index opened at 5249.10 on the first trading day of the calendar year but within three days had fallen below the much-watched 5000-point level.

The see-sawing index managed to finish the quarter above the 5000 mark at 5043.63 after a spurt on the last day of March. It was down 3.91 per cent for the quarter.

Investors who allow such abrupt short-term movements on the markets dictate their investment decisions are falling into what could be called the volatility trap.

Investors who fall into this trap often surrender their carefully-diversified long-term portfolios in an attempt to time the market. That is, trying to pick the best time to buy and sell stock.

However, most market-timers tend to sell stocks when prices have fallen – often seeking the perceived shelter of all-cash portfolios during periods of intense volatility – only to buy back into the market when prices have already recovered. In other words, such investors lock-in their paper losses.

When markets are particularly volatile, many investors also tend to focus solely on the changing prices of their shares, overlooking the critical contribution that dividends make to their total returns.

And yet another element of the volatility trap is that investors can lose their confidence about investing more of their savings into the market. This is despite the need for most of us to save for retirement and to meet our other goals.

One way that countless investors sidestep the perils of market-timing to keep on making new investments throughout changing market conditions is to practice the straightforward strategy of dollar-cost averaging.

Dollar-cost averaging simply involves investing the same amount of money into the sharemarket over regular time intervals – regardless of whether share prices are up or down.

Investors practising dollar-cost averaging buy more shares (or units in managed funds) when prices are lower and fewer when prices are higher. In short, purchasing costs are averaged over the total period that an investor keeps on investing – thus the name dollar-cost averaging.

Nevertheless, the core benefit of dollar cost averaging is not so much the price paid for shares; it is the adherence to a disciplined, non-emotive approach to investing that is not swayed by prevailing market sentiment.

The strategy can assist investors to focus on their long-term goals with an appropriately diversified portfolio while avoiding emotionally-driven decisions to buy or sell.

It should be emphasised that dollar-cost averaging does not guarantee that investments will succeed; nor does it protect investors from falling share prices. It does help foster sound investment practices.

Good investors know how to handle volatility. It is a fundamental skill. And that skill may be increasingly needed given that the 2016 Economic and Investment Outlook points to a “more challenging and volatile” investment environment over the long term.