Mention the South African Rand nowadays and it tends to conjure up negative thoughts and emotions for most people. But not everything associated with the word “Rand” is negative though.
A powerful investment technique known as “Rand cost averaging” provides a stable way for investors to accumulate wealth during tough economic times without having to invest more.
Rand cost averaging is an effective investment technique best applied when things in the economy and investment world becomes a little uncertain or bumpy.
With Rand cost averaging investors are able to accumulate more of a certain type of investment with the same amount of money in bad times than they could in favourable economic times.
Let us consider an investment in a *unit trust to help explain how rand cost averaging works. When investing in unit trusts the general idea is to buy (accumulate) as many units in the unit trust as possible over time to improve your overall wealth.
John wants to invest R 100 per month in a unit trust for the next 20 years. John pays R100 over to an Investment Manager (the person that manages and runs the unit trust) who buys him a certain number of units in the unit trust. On 1 September John buys 100 units. His 100 units is made up as follows: the price of one unit in the unit trust on 1 September was R1 thus John’s R 100 investment bought him 100 units in the unit trust (100 units x R1 = R 100).
The unit price of a unit trust changes on a daily basis and can either go up, down or remain relatively stable depending on the type of unit trust and the activity within the markets in which the unit trust invests.
On 1 October the unit price of the unit trust in which John had invested was R2 as the markets had improved. On this day John buys another R100 worth of units in the unit trust. This time his R100 only buys him 50 units (50 units x R2 = R100).
On 1 October he has invested R200 in total and he owns 150 units in the unit trust. His total investment is valued at R300 (150 units x R2) as at 1 October.
On 1 November the unit price dropped sharply from R2 to 50c per unit due to unfavourable market conditions. On 1 November John invests another R100, however this time his R100 buys 200 units (200 units x 0.50c = R200).
John now owns 350 units, but the unit price has fallen and so his total investment has decreased. On 1 November the total value of John’s investment stands at R175 (350 units x 0.50c = R175). But John is investing for the long term and therefore ignores the short-term market noise, sticks to his 20-year investment plan and does not sell due to panic and market pressure.
By 10 November the unit trust price has recovered substantially and moved to R3 per unit taking John’s total investment value to R1 050 (350 X 3 = R1 050).
John patiently and consistently invested the same amount every month and thus was able to take advantage of accumulating more units in the unit trust when markets fell and hence improved his total wealth.
Instead of staying out of the markets when times turned bad, John applied the rand cost averaging technique knowing that it was a great opportunity to increase the amount of units he could buy without having to invest more. When markets improved he was ultimately better off and managed to substantially boost his overall wealth.
Markets will rise and fall over time. Instead of shying away from investing when times are bad rather apply the technique of rand cost averaging in order to really get ahead when things improve again.
*A unit trust pools money received from many investors (or members) together into one investment fund, known as a unit trust. The members then share in the growth or losses in proportion to the number of units that they own in the unit trust. The value of an investment in a unit trust is measured daily using the following formula: The number of units an investor owns in the unit trust multiplied by the price per unit on that day.
Amounts and performance figures used in this article are for illustrative purposes only. Returns or benefits are dependent on the performance of the underlying assets and variable market factors