Why you should start a regular investment contribution even when the markets have been volatile.
Many would-be investors might be tempted to delay getting started
when investment markets have been volatile.
But let’s see why that shouldn’t be much of a concern at all, to an investor who is thinking about
setting up an automatic, regular contribution to a properly constructed investment portfolio.
Let’s assume our investor is starting from scratch
and is beginning to invest with a regular contribution of $100 per month.
If they were simply socking money away under their mattress,
their balance would increase in a straight line, leaving them with $1,200 at the end of one year.
But now, let’s assume that they put this money into an aggressive portfolio,
and that the markets have a bad year.
Let’s assume their portfolio loses 1% per month, systematically.
Their January contribution of $100 loses 1%, or $1 to start February at $99.
But then we add in February’s $100 contribution and our account balance increases to $199.
We again lose 1% in February, and 1% of $199 is equal to $1.99, bringing our balance down to $197.01.
We continue this over the course of the year…
and we’ve contributed $1,200, but our ending portfolio balance is $1,124.79.
We’ve lost $75.21 in this poor performing year.
If we look at the calendar year return for the underlying investment, it lost 11.36% for the year.
A double-digit loss doesn’t sound very nice,
but from the perspective of our new investor who is starting from scratch,
losing $75.21 is unlikely to financially devastate them.
Of course, markets rarely march up or down in an orderly fashion.
Let’s look at one more scenario where the market absolutely crashes early in the year,
recovers somewhat for the rest of the year,
but the underlying investment is still negative for the year.
You might be surprised to learn that an investor just starting out might actually
end up with more money in their account at the end of the year than what they put in.
In this scenario, the first three months of the year see the underlying investment decline by 10%, 20% and 5%,
before stabilizing and starting to recover during the rest of the year.
The underlying investment’s performance for the year is actually -13.61%.
But our new investor who is adding $100 per month to this investment
will end up making money by the end of the year.
The original $100 investment drops to $90 after the first month.
When we add in February’s $100 contribution, we start February with $190.
February sees the market meltdown by 20%, leaving the balance at $152.
We add another $100 at the beginning of March, but our account loses another 5%, leaving us with $239.40.
But at this point, the market starts to rebound,
not as dramatically as it declined, but the balance of the monthly returns are mostly positive.
Filling in our table, we slowly but surely see our account balance increases to end the year at $1,303.44.
We are actually up $103.44 over our $1,200 in contributions for the year,
over our $1,200 in contributions for the year,
even though the underlying investment’s return for the year was -13.61%.
This is because the poor performance of the investment occurred early on,
when we had relatively little money in the investment.
So, we’ve just seen two examples of how even double-digit negative returns for an investment over a year
don’t lead to a devastating dollar loss for new investors starting from scratch.
Yes, markets are unpredictable, and it’s possible that someone investing $100 per month
will see performance worse than what we have demonstrated here,
but over a multi-decade investing career, even that would be a drop in the bucket
compared to what you should be prepared to see at various times in the future.
So, if you aren’t starting to invest with a lump sum,
but instead are looking to start with a regular, automatic contribution,
you really shouldn’t worry too much about waiting for the right time.
Even if you start right before a market crash, in absolute dollar terms,
you’re probably not going to feel it as much as you might think.