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The really annoying thing about many of my shares is that they keep going up. Of course as far as problems go, this is a pretty good one to have, but nevertheless a problem it remains. To understand why this is the case, you need to appreciate the following:
- I have a long term investment horizon (at least 5 years, probably more than 10)
- I do not currently possess all the investment capital that I will accumulate over my life
- I want to maximise my total return prospects
Like all other investors I want to maximise my total return prospects. Obviously, the lower my entry price, the better my eventual total returns: in terms of both capital growth and yield, a lower entry price is always better.
Now if I had all of the money I will ever earn, save and invest at my disposal, right now, I would want prices to rise immediately and aggressively as soon as I make a purchase. Sadly though, that is not the case (and I suggest is not the case for the majority of us). I am likely to remain in the workforce for at least another 10 years and as such I will be looking to make regular contributions to my portfolio as I go.
If share prices continue to appreciate, each additional purchase will have lower capital gains potential and a lower yield potential. In fact, the ideal situation for someone like me is to see markets move sideways or even down for the next few years. Needless to say I would need an eventual price appreciation, but I want to prolong that as long as possible.
In a sense I am forced into a type of compulsory dollar cost averaging. Not because I am trying to capitalise on depreciated prices (although I am), and not because I am trying to time the fluctuation in short term prices (which I am most certainly not). I am dollar cost averaging because it is a logistical inevitability. To reiterate, I simply do not currently possess all of my eventual investment capital.
As any study into wealth creation reveals, the most important determinant of your long term wealth is the amount of money you manage to save and invest. Of course investment returns are important; it is just that they aren't as important as savings levels. People who fail to grasp this most basic of concepts are doomed to continue chasing easy and instant fortunes through a range of investment gimmicks. It is a real tragedy.
To understand why an instant rise in price is totally unnecessary let’s examine the following example. Consider two scenarios: the first sees the market experience a steady 10% annual rate of growth, while under the second scenario the market suffers a fall then a protracted sideways movement. (See below)
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As you can see, under the second scenario the market remains about 25% below that experienced under the first scenario after 10 years. Now let us assume that in both cases we invest $10,000 at the start of the period and then commit a further $2500 a year. The surprising thing is that the investor under the second scenario has done better!)
Portfolio performance:
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When the market was depressed you were able to get more ‘bang for your buck’, so to speak. It meant that when the market did eventually start to appreciate there was a larger capital base exposed to the upward movement, and from a dollar and cents perspective, a superior return.
Admittedly the outperformance is small under this example, but the point is to demonstrate that a falling and sideways moving market should not cause a great deal of concern for longer term investors that can diligently follow such a simple strategy. Unlike those that rely on trying to correctly anticipate the short or even medium term direction of the market, these investors simply rely on prices being suitably higher over the long term; something that history reveals to be a very realistic outcome.
So let the market fall, let prices move sideways, I couldn't care less! It’s the destination that matters, not the journey. Besides, the beauty of having a focus on dividend paying stocks is that I get continuous cash rewards just for holding my shares. And if it is growth rather than income I am after, well all I do is reinvest my dividends and let the power of compounding go to work. A topic perhaps for another day.
Make the markets work for you
Andrew Page
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