In today’s Exponential Investor…
- Lockdown or no lockdown?
- Invest either way
- How to ‘DCA’
Now entertain this thought…
What if there’s no lockdown on Thursday?
After everything we’re supposedly about to go through again what if the whole thing is called off?
There’s bubbling speculation that perhaps the data used to send the UK into another lockdown is…wrong.
Contain your surprise. Wind in that shock.
There’s a growing voice the most recent data about the spread and cases of covid-19 is actually showing a decline. That perhaps this ‘second wave’ isn’t going to be anywhere near as bad as the first and that lockdown this Thursday isn’t going to be necessary at all.
Of course, my view is that another lockdown will be catastrophic. It will be the final nail in the coffin for thousands of small businesses across the UK. It will send even more people into poverty and financial despair. It will see ongoing long-lasting problems with the broader community’s mental health and it will see more drop offs in consultations and admission to the NHS.
From the first lockdown there was a huge drop off in NHS admissions and consultations, over 50%. Another lockdown will see that pattern repeat.
However, what if it doesn’t come?
Could it be that on Thursday, we’re back to localised ‘Tier’ managed systems and no national lockdown? If the lockdown is cancelled, you might want to prepare your cash for it.
Prepare for volatility
If there’s no lockdown this week (unlikely, but still a possibility) it looks like the UK market could be in for a fresh injection of optimism.
Rejecting a second lockdown now, might be the confidence everyone needs to see that lockdowns aren’t necessary at all. After all, there are members within the World Health Organisation that are actively saying the government shouldn’t use lockdowns as a primary method of control for this pandemic.
We also know the untold damage it does to an economy and the collateral damage that brings.
No lockdown might be the turning point, the inflection point, the moment of 2020 in which everything takes a significant turn for the better.
If that’s the outcome then the UK market could head off on a run and not look back.
In which case, you’ll want to have some capital ready to invest before that truly kicks into gear. Usually the best time to move on something of significance like a no lockdown U-turn is before the event.
But that’s taking on a lot of risk and potential volatility if lockdown proceeds as planned.
That’s why yesterday I made note of a strategy called dollar-cost averaging into the market with your investment.
Dollar-cost averaging is a way to invest in the market to help smooth out volatility and to not pin all your capital potential to one entry point.
You might also hear us sometimes refer to it as ‘drip feeding’ into the market.
It’s a simple premise that can help long-term investors.
What you do is once you’ve decided how much you want to invest into the market, and into a particular position, you invest in smaller more regular points to build your position.
That way if the market moves down, you can average down your cost base for that position. Of course if the market moves higher you average up your cost base, which isn’t ideal.
The whole point to dollar cost averaging is to mitigate risk, not eliminate it, but mitigate it.
The numbers can work for and against you
Here’s a dollar-cost averaging (DCA) example.
Let’s say you want to invest in Stock A at £1. You’ve got £1,000 to invest.
You could invest the whole amount at £1 getting 1,000 shares. But perhaps Stock A is exposed to a number of factors in the short term, which see it trade with a lot of volatility.
Those factors push the stock 10% lower over the next week. You’ve got your 1,000 shares, but you’re now 10% down.
By dollar-cost averaging, you might invest £250 in the first instance at £1, getting 250 shares. Then a week later, you invest another £250 this time, you pick up 277 shares. Maybe the week after the price moves another 5% lower to 85.5p. You invest another £250 picking up 292 shares. And then the next week the stock perhaps jumps 20% back up to £1.026 and you invest the final amount picking up 243.
This way you’ve invested your £1,000 but picked up 1,062 shares instead of the 1,000 you’d have got by putting it all in at once. Also, ongoing you might put in another £250 a month, again the price will vary, but as you continue on over time, you average out your cost base, regardless of the stock being up down, or in between.
For a long-term investor, it can be a valuable long-term strategy to build up a strong position in a stock, helping to smooth out volatility.
Of course, it can move against you. You might invest a little bit, then the stock rises the next week, and the week after, and the week after that. Your cost base then is higher, and you’ve got less shares than you’d have got if you put it all in at £1.
That’s the risk/reward trade off you’ve got to get comfortable with.
Also you need to factor in the cost of transacting. More transactions usually means more brokerage fees, so you must also weigh up the costs of trading too in deciding if dollar cost averaging is for you or not.
But it’s worth considering, particularly if you’re looking at a stock or stocks for the long term, where you want to build a long term position and want to try and dampen the short term volatility that current markets can present.
This kind of volatility if in abundance in industry right now like hospitality, retail, travel, tourism and events. These are just five industry sectors that are being toyed and strung along by these tumultuous events, like lockdowns.
This can force their stock prices higher and lower by double-digit swings in a day. That’s crazy volatility, and it can scare investors away from taking action at all.
That’s why in high volatility sectors and markets if you apply a DCA strategy, if there are stocks in those industries you like long term, you can smooth out that volatility by using this strategy.
Something to consider and to look at this week and the coming weeks as everything teeters again on the edge.
Editor, Exponential Investor