Averaging a strategy to succeed

YOU wouldn't be blamed, or even completely incorrect, if you thought rich investors were rich because they have investment smarts. That is, they know exactly what companies to buy and when.

That's why many of us hand investment decisions over to a fund manager that picks stocks for a living. Or a stockbroker. Or a financial adviser.

Some wealthy investors are wealthy because they do make smart investment decisions - Warren Buffett springs to mind - but it turns out if we do try to time the market - that is, buy at the point where it's going to be cheapest to sell when it rises to its peak - more often than not we're going to be wrong.

That's the opinion of Burton G. Malkiel - the author of the famous investment book A Random Walk Down Wall Street. It was first published in 1973 and is now in its 10th edition.

In it Malkiel advocates a buy-and-hold strategy and says that will make you more money over the long term than trying to time the market.

"If anyone was able to correctly time the market that would be a wonderful thing but there is no genie that tells us this is the time to buy and this is the time to sell," he says.

Malkiel says that if he knew Buffett's Berkshire Hathaway was going to do so well 20 years ago he would have thrown away his preferences for index funds - which he believes are the best tool for a buy-and-hold strategy - but the problem is none of us will ever know who the next Buffett will be.

He disputes suggestions that the advent of the global financial crisis and increased sharemarket volatility means his strategy doesn't work any more.

"A lot of people say markets have been very volatile," he says. "So many people say the old rules don't work any more ... I think the old rules are more relevant than ever."

Although he never discloses his wealth, Malkiel is a well-off individual thanks to his strategy - and the sale of thousands of his books probably helps as well. But what can the rest of us do with our investments to avoid the hubris of a market boom and the panic of a market crash?

Dollar-cost averaging is a good start. This is the idea of spreading out your investments over a period of time. If you bought $1000 worth of share X three months ago at $1 a share and the price rises to $1.50, when you buy another $1000 worth today you'll be better off than if you bought all of them today. Instead of paying $1.50 for every share your cost is averaged to $1.20 for the period.

The accompanying table shows you how this works for investing in an index fund (a selection of all the stocks in an index such as the ASX/S&P 200) and would work just as well for an exchange-traded fund (ETF). Treat your dollar-cost averaging as a long-term savings plan. Ignore the ups and downs and don't stop doing it if you get scared by market falls.

Another simple strategy is rebalancing. If you set out with the idea of having 60 per cent in equities and the rest in cash or fixed income, then at the beginning of each year you need to make sure the value of your equities hasn't risen or fallen to change those allocations. If it has, you need to fix it.

Malkiel doesn't have all his assets invested in the one basket. He takes bets around the edges but believes if the majority of his money is in indexed funds then he can afford to do so.

He cites a portfolio recently established for a new grandson as an example. It has 85 per cent in a global ETF and the remainder in allocations to Brazil and China. Malkiel feels those countries are not sufficiently represented in that index relative to their importance in the global economy.

"Investing is fun," he says. And it's even more fun when you're not betting the house on the short-term whims of the market.

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