Bear market: working for smart investors

Over the past decade, many South Africans have fallen into the trap of increasing consumption at the expense of savings, and accumulating debt in the process. What is needed is a return to basic investment principles.

Between 1995 and 2007, the gross level of savings in South Africa, measured as the proportion of household revenue that is not spent, dropped significantly from almost 4.5% to under 2%. This worked while money was cheap and asset prices were rising, but unfortunately the tide has now gone out and many people have been left exposed.

The average South African needs to accumulate capital via a regular stream of investment contributions over time. The good news is that these investors have two basic investment principles working for them – time in the market and buying through the dip.

It's time in the market that counts

No matter what the dream or goal, the sooner a person starts saving for it, the better. It is a fact based on the principle of compound interest, which basically means that interest is earned upon the interest already earned, so that the effect is a dramatic snowballing of the money invested and the interest realised.

Getting started earlier

But, this effect only works over a long period – the longer the better. Which is why starting earlier with less can be so much more effective than starting later with more.The table below highlights the importance of an early start. The person who starts investing R500 at the age of 25 comes out with R2 797 304 - the same amount as the man who starts investing R13 830 at the age of 55 receives.

Start at age    Period of investment    Monthly investments    Total investedFinal value

25/40 years   R500                           R240 000                   R2 797 304
35/30 years   R1 345                        R484 200                   R2 796 649
45/20 years   R3 855                        R925 200                   R2 790 969
55/10 years   R13 850                      R1 662 000                R2 790 187

Based on Old Mutual Investors Fund for period ending December 2007

Buy through the dip and benefit from Rand cost averaging

Investors who are still building up capital are "net consumers" of investment units – i.e. they are accumulating investment units. They should thus be delighted when the cost of investment units goes down, which is exactly what has happened over the past year as markets have dropped off.

The long-term investor is now in a position to benefit from the principle of Rand cost averaging, namely that the monthly investment is now buying more (cheaper) investment units than before. The smart move would be to ignore the ups and downs of the market and simply invest regularly through a volatile period. It has been shown time and time again that investors will build up significantly more capital if they continue buying when the markets are falling.

The graph below shows the period between July 2002 and May 2003 where the JSE All Share Index lost a third of its value before it turned and rose again. Two and a quarter years later the market was only 5.8% p.a. up on the pre-dip high, yet investors who had continued investing monthly gained 22.4% p.a.

Now is the time to return to the basics and allow the bear market to work for investors.