Spending too much time worrying about entry points when you are trying to start investing can often lead to needless delays and possibly never even starting at all. I know it is very cliche but there really is some truth to “time in the market, beats timing the market”.
An almost fool proof way of investing your money is by using the Euro Cost Averaging method.
What is Euro Cost Averaging?
Euro Cost Averaging is an investing strategy that involves spreading out your capital over a number of time periods instead of investing it all at one specific point in time. The benefit of this approach is that you can reduce the risk of mistiming the market.
When you invest with a lump sum there is always the risk that you have invested at a market top. According to a recent Forbes post, market crashes since 1945 have seen the stock market drop by 32% on average. Therefore it could be a very costly decision by going in with one big lump sum.
While many are firm believers in the power of using technical analysis and chart reading to be able to predict future price movements. Time and time again technical analysis can only assist you in times when nothing extraordinary is happening that affects the market. The techniques break down completely when black swan events or unexpected bad news hits the market.
Unless you are someone who is really committed and wants to spend most of your waking hours analysing changes in financial ratios of companies and stock patterns then it is probably best to go with a strategy such as Euro Cost Averaging.
The downside of the Euro Cost Averaging approach is that you will have more transactions which could lead to higher transaction fees. But this will be highly depended on the broker that you are using.
This is all good in theory but let’s put some actual numbers on a real-life scenario to see when Euro Cost Averaging is worthwhile and when it is not.
When prices are fluctuating: the Euro Cost Averaging strategy in the scenario puts the investor in a much better position than if they were to invest all of their funds in one lump sum. The investor ends up with 347.44 shares compared to 300 shares if they decided to invest with a lump sum.
When prices are rising: this is not the case when prices are rising. In this scenario, the investor is much worse off, ending up with 43 fewer shares than using the lump sum method of investing.
When prices are falling: If we now consider a situation where the share price is falling, the Euro Cost Averaging strategy works out very well for the investor. The investor ends up with 37 addition shares compared to if they had invested with one large lump sum (337 vs 300).
Based on the above example, Euro Cost Averaging is a very useful investing strategy in times of market volatility and also when prices are falling.
It can be very difficult to time the bottom of a market, but with Euro Cost Averaging you can even out the market bottom. You won’t get the exact market bottom price but you will get something not far from it.
The only situation which Euro Cost Averaging doesn’t make sense is when the price of the stock is increasing consistently.
Although it is hard to predict how the market will behave in the coming months, a simple idea of how it is trending is all you need to know when deciding whether to Euro Cost Average or to invest your money in all one big lump sum.
Euro Cost Averaging will keep you agile, by spreading out your investments and having capital sitting on the side you will be able to take advantage of any opportunities that my arise. A stock you have been watching may drop all of a sudden and you will be able to quickly capitalise on the opportunity on short notice.
An added benefit of using using an Euro Cost Averaging strategy is that it will help you build a regular habit of investing your money. If you are routinely investing some of your monthly salary then you will likely invest greater sums in to the future and the larger capital invested the higher potential returns you could achieve.
Disclaimer: This blog post is for informational and educational purposes only and should not be construed as financial advice.