I've not been more excited about the current market conditions as now. To be fair, this is my second market crisis. The first one I've personally encountered was in 2016 where China Circuit Breakers got triggered. Back then, I made a 30% return on my investment and my biggest lesson was that investing is only meaningful if you have a decent amount of funds. I just started working not too long ago and savings wasn't that substantial.
Fast forward 2020, I've learnt from my lesson and this time can approach the market better prepared. This is probably the first crisis I'm experiencing that might trigger a recession. So recently, in the financial groups I'm in as well as my own firm's market update, the common consensus is that people are looking for a crystal ball to identify the market direction moving forward. Why did market tank 30% then recover 20% ++? Why is market data so bad yet markets still continue to go up? Is the worst over? Is this a dead cat bounce?
Frankly I don't know either. However, we can make sensible plans on how to approach this market and doing so might help ease up on the need to find a crystal ball.
What is Lump Sum Averaging?
Lump Sum Averaging (LSA) is a term I invented. You can't google this term. What it basically means is to deploy a proportion of your lump sum at certain pre-determined value points of the market. This strategy is only applicable during a market crisis.
This idea is less common to more popular strategies like dollar-cost averaging (DCA) and lump sum investing. In fact there has been a number of literature studying which method is better and data seems to support lump sum investing as the better performing option. However, it should be noted that lump sum investing is also commonly associated with trying to time the market and market timing is generally a losing battle. Having said that LSA is not new.
The biggest benefit of DCA is taking away the need to time the market. However, in an economic crisis, it exposes someone with a lump sum to stalling on the deployment of a significant portion of funds which may have an opportunity cost on the returns. The idea of LSA is a middle ground that captures the benefits of DCA and lump sum investing. This idea hinges on the principle of buying low and selling high. By deploying a proportion of funds at various stages of a market crisis, you benefit from a greater gain if markets rebound after a correction as compared to monthly averaging through DCA but also do not risk exposing all your capital to a fixed value point in the event market drops further.
Looking at past recessionary crisis
I took time to look at the past few recessionary crisis since I was born. There are a few telling information if we look at the data. To make illustration easier, I think it's safe to use the US Market as a case study.
1998 (Asian Financial Crisis)
2000 (Dot Com Bubble)
2008 (Subprime Crisis)
2020 (Covid-19 Crisis)
I excluded 2011 European Debt Crisis and 2016 China Circuit Breaker because they were not recessionary. What you can see from these crises is that major dips range between 20% - 50% over the period 1998 - 2020 (crisis period not yet ended). We also notice that each significant swing ranges from 15% to 35%. This happens in most crisis so far.
How Lump Sum Averaging Can Be Implemented
What knowing this data means is that we can insert certain conditions of when we choose to deploy our lump sum in equal proportions or based on a percentage we are comfortable with, to enter the market as it drops. Given that market crisis behavior are somewhat similar, the conditions of how and when the funds get deployed can be decided way in advance. So when market drops by a certain percentage, we will make an emotionless decision to deploy a percentage of our funds simply because we are happy to invest this portion of our capital at the determined value. We will continue this exercise till all the funds we wish to invest in this crisis are deployed.
So what is the biggest benefit of this approach?
In the latest crisis, markets dipped by more than 30%. As of now, markets seems to have rebounded 28%. A typical investing psychology of most retail investors is waiting too long when markets are falling because they assume markets will fall further and buying too hastily when markets rebound because they fear missing out. This strategy simply pre-programmes the decision to buy at certain percentage drops thus taking away the need to second guess the market. You can't time the market anyway.
So what happens when you only deployed 30% of your capital and markets rebounds and never looks back? Well, if there are signs that the bull trend have resumed, you can return to your usual investing strategies you use pre-crisis. Having said that, judging from past crisis data, I'll say that as long as you position your lump sum averaging wisely, you would have deployed a good portion of your capital at good valuations prior to a market recovery.
Summary
In short, this article is simply an idea sharing session on some ways to mitigate the urge to try and forecast the future of market movements. An investing or trading plan has always been about knowing what to do in various market conditions even before deploying cash into the markets. This way emotions would be better managed and decision making can be more rational.
Should you decide to try out this strategy and is fairly new to investing, do speak with a trusted advisor. Alternatively, you can drop me a message if you would like me to help you with it.
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Disclaimer: The content created are based on my personal opinions and may not be representative to everyone or any organisation. If you have any doubts or queries pertaining to insurance or investment, please seek professional advice from a trusted adviser in an official setting. You may also reach out to me if you do not have a present adviser using the message box under 'Let's Talk'.
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