16 Nov 2011 | Colin Renton

Regular saving or lump sum investment? 

It’s little wonder that some investors have shied away from equity markets during 2011. After all, volatility has driven violent swings that have lopped big chunks from values one day, only to reinstate them in the following session, with no logic or pattern to these moves.

The irrational nature of sell offs and rallies has meant that companies with strong fundamentals – good long-term prospects, strong financial positions, solid management – have been punished as harshly as those lacking all of these attributes. Consequently, these have been frustrating times for everyone concerned.

Baillie Gifford’s teams hold many stocks which continue to offer compelling investment prospects over the longer term. Yet, even several of these have been caught up in extreme volatility fuelled by economic uncertainty, which in turn has been exacerbated by political posturing.  

The capricious shifts have offered a chance for speculators to make money if they can guess which stocks will be hardest hit or will rise the most. However, for short-term gamblers, trying to identify the likely winners has been akin to throwing a handful of blunt darts and hoping that one would stick in the dartboard.

So, is this an appropriate time to consider an investment trust? And, if so, how do you know that the fund that looks attractive today won’t have been clobbered – or won’t have bounced to high levels – by the time you hand over your money?

It doesn’t matter too much for investors who adopt a realistic timescale. At some point in the future, rational behaviour will return to investment markets. The strong companies will eventually regain their place as the best performers over a period of five years or more.

There are still many reasons to invest in equities, and long-term prospects are arguably more attractive now than they were 12 months ago. Despite the pervasive negative mood, there are still powerful, positive influences such as the rapid growth of developing countries and the fast pace of technological advances, which will eventually be reflected in strong returns for well-structured companies. 

One way to address the current volatility might be regular saving rather than making a lump sum commitment. So, for instance, that £6,000 earmarked for investment might be better employed if it is dripped in at £500 per month. This should help even-out some of the peaks and troughs by offering the benefit of pound/cost averaging.

If shares are priced at £1 each, the monthly investment will buy 500 shares. A 10% fall in market values over the next month will buy a further 555 shares. Should they then return to the initial price of £1 each, the shares owned will be worth £1,055 on an investment of £1,000, an average cost of 95p per share. However, if markets rise from one month to the next, the number of shares purchased will reduce. But, the effects of future market falls will appear greatest for those fewer shares purchased at the higher price and the impact on the average price will be lessened. 

It may not solve the problem of volatility, but the concept of averaging might sharpen the darts and offer a better chance of scoring.