Money: Index fund timing worries can be beaten

By Mary Holm

Money Matters


Q. Following your column last week, let's assume one should be in an index fund, about which there can be little debate.

Now let's think about the entry strategy of getting into the fund - there is more than one! It is my very firm conviction that the only valid entry strategy is $x per month over very long periods, comparable to your lifetime savings period.

The alternatives imply you know more than the market, in that the current market index prices represent value, which they may not.

What I am arguing is that by dumping your savings into an index fund at a point in time totally defeats the purpose of an index as simply a passive tracking fund with no claim to superior market knowledge.

Warren Buffett is quite strong on this point in one of his letters to shareholders some years back.

We need to remember that the US market over 100 years can be characterised as a few years of strong growth, followed by sharp declines, followed by long periods of virtually no growth, while still averaging a reasonable return.

Just entering an index fund with a lump sum at a point in time exposes you to the above and could be devastating to someone who is thinking about retirement in five to 10 years, which may not be longterm in the market-performance sense. I would be interested in your thinking on this.

A. I'm with you, but only so far. Certainly, if you decide that from now on you want to put your savings into an index fund - or any other investment where the value rises and falls - it is a great idea to dripfeed the money in at $x a month, or a week.

That way you get the benefit of what is called dollar cost averaging. Sometimes you will buy when the price is relatively low, sometimes when it is high. But because you are putting in the same amount of money each time, you will get more units when the price is low.

With more cheap units, the average price will be lower than the average market price over the period.

Here is an over-simplified example: say you put in $100 a month for two months. The first month the market is low and you get 10 units at $10 each. The next month it is high and you get five units at $20 each. The average market price is $15.

You have a total of 15 units, and you paid $200 for them. Your average price is $13.33.

You do not have to pick the right time to buy. You are just in the market the whole time. It is easy and it works well.

But what do you do if you are a recent convert to index funds - or another share investment - and you have a lump sum available to invest? I say do it now.

Your alternative is to dribble the lump sum in gradually. Meanwhile, the rest of the money is sitting somewhere else.

There is, of course, always the danger that you will put your lump sum in the market at the worst time, right before a strong growth period turns into a sharp decline.

And, if we are talking the US sharemarket - or even the world sharemarket - there are plenty of people around who reckon that could apply to now.

However, there have been gloomy forecasts for the American market for several years now. They have not come true yet.

Nor can there be any guarantee that the recent US boom will be followed by a bust. It could just develop into one of your "long periods of virtually no growth," with no drama first.

You worry about the five to 10-year investor. But while sharemarket indexes quite frequently drop over single years, it is uncommon for one to drop over any five-year period. Over 10 years it is rare.

Perhaps someone who thinks they will need their money in less than 10 years, or someone who is nervous about it all, should invest, say, a third now, a third in six months and a third in a year.

Perhaps, too, they should put part of their money in term deposits, or some other less volatile investment. In fact, if the whole thing bothers them too much, they might be best to stay out of a share investment altogether.

I think those with a reasonable stomach for risk who are in for the longer term might as well get into the market now.

Nobody can promise that things will come right. But they always have in the past.


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