By Peet Serfontein
Rand-cost averaging (RCA) is an investment strategy that, in theory, minimises the impact of market volatility by investing in a company over time, instead of investing a lump sum at once. By investing a fixed amount of money regularly, investors buy more shares when prices are low and fewer shares when prices are high. This approach can help reduce the average cost per share over time, mitigating the risks associated with market fluctuations.
What is rand-cost averaging?
RCA is the South African variant of the widely-known dollar-cost averaging (DCA) strategy, named so because it applies to investments in the local currency, the South African rand (ZAR). The strategy involves committing a fixed amount of money to invest at regular intervals, regardless of market conditions. This method stands in contrast to trying to time the market, where investors attempt to buy low and sell high, a risky endeavour given the unpredictability of short-term market movements.
In essence, RCA allows investors to focus on consistency and long-term planning. It eliminates the pressure of guessing the right time to invest, as investors are less concerned with short-term price movements and more focused on building their wealth steadily over the long haul.
How rand-cost averaging works
The concept of RCA is simple: instead of investing a large sum all at once, you invest small, equal amounts regularly over a defined period-say monthly, quarterly, or annually. Each time you invest, you purchase units or shares of your chosen investment, such as equities, exchange-traded funds (ETFs), or unit trusts. The price of the shares or units may vary at each interval, but since you are investing the same amount of money every time, you automatically buy more units when prices are lower and fewer when prices are higher.
Example of rand-cost averaging
You want to invest R1 200 into a particular unit trust fund. Instead of investing the full R1 200 at once and buying 24 units immediately, you decide to invest R200 per month for six months.
| Month | Unit Price (ZAR) | Amount Invested (ZAR) | Units Bought |
|---|---|---|---|
| 1 | 50 | 200 | 4 |
| 2 | 40 | 200 | 5 |
| 3 | 60 | 200 | 3.33 |
| 4 | 55 | 200 | 3.64 |
| 5 | 45 | 200 | 4.44 |
| 6 | 50 | 200 | 4 |
| AVERAGE/TOTAL | 49.15 | 1200 | 24.41 |
Over six months, you will have invested R1 200 in total. The number of units you own varies based on the price at each point, but by spreading the investment over time, you benefit from purchasing more units when prices are lower. In this scenario, you own approximately 24.41 units after six months, and the average price per unit is R49.15, which is lower than some of the higher prices during the period.
The benefits of rand-cost averaging
RCA offers several important benefits for investors. These benefits can help improve long-term outcomes, particularly for those looking to minimise risks and reduce emotional responses to market fluctuations.
Drawbacks and limitations of rand-cost averaging
While RCA has many benefits, it is not without its drawbacks. Investors should be aware of these limitations when considering this strategy.
Rand-cost averaging vs lump-sum investing
One of the key debates in investment strategies is the choice between RCA and lump-sum investing. While RCA focuses on spreading investments over time, lump-sum investing involves making a single large investment at once. Both approaches have their advantages and disadvantages, and the best choice depends on individual circumstances.
Lump-sum investing can result in higher returns if the investment is made during a market dip and prices rise shortly after. However, it also carries higher risk, as a poorly timed investment can lead to significant short-term losses. RCA, conversely, reduces the impact of poor timing but may not capture all the potential upside of a sudden market rally.
For most investors, particularly those who are risk-averse or uncertain about market timing, RCA provides a more balanced approach that offers protection against market volatility while still allowing for long-term growth over time.
