“We’ve lost money?”
“Yes, but it’s early days yet.”
“I’m not sure. Maybe we should pull out of this and cut our losses?”
This conversation is familiar to investment managers all over the world. The pattern is established: A wealth manager starts a monthly contribution of their client’s money into a fund, or fund of funds, for a long period, but after a year or two the figures are red and preceded by a minus sign. At the periodic meeting to review the portfolio, the client recoils if he sees his money shrinking.
That wasn’t what was supposed to happen, the client will think.
"The wealth manager, then, has the task of explaining something that the client likely views as counterintuitive"
True, but there is more to this than meets the eye.
While one should never deplore a steady upward trend in a fund, when it comes to consistent monthly investments in the portfolio, a downward trend in the early years could be even more desirable. As the price drops, the client’s money is able to buy greater numbers of units month-to-month. When the fund bottoms out and begins to rise again, the greater volume already purchased begins to tell.
If, on the other hand, the fund only rises, each month’s money goes steadily less and less far, so eventually the client ends up owning fewer units, and therefore gets less for their money over time.
This process, called dollar-cost averaging, works. It is a very effective method to increase the buying power of a monthly investment plan, and brings significant increases in returns over the long run.
The problem with dollar-cost averaging, though, is that it requires the client to have the courage to stick with the plan despite market volatility. Paper losses are likely to be reversed if the plan is seen through to fruition, but if a client takes fright and pulls their money out then everybody loses – the fund manager, the client and the lowly wealth manager.
Stories of clients who panicked and yanked their investments early are rife in the industry. Some companies even have software that will track the returns that could have been made if the client had just heeded advice and weathered the down days.
The wealth manager, then, has the task of explaining something that the client likely views as counterintuitive: Provided the right funds are in the portfolio, a performance sheet swimming in red is not necessarily bad.
Paul Seligman is an investment adviser at Meyado Private Wealth Management in Singapore.