Rand cost averaging is a wealth-building strategy. It involves investing a fixed amount at regular intervals over a period of time in an investment vehicle that has a fluctuating price, such as unit trusts or shares.

The concept of rand cost averaging is relatively simple. "By investing a fixed rand amount on a regular basis, one buys more units or shares when prices are low and fewer when prices are high," says Dr Prieur du Plessis, Plexus group chairman. "In addition to being an easy and affordable way of building long-term wealth, with rand cost averaging in declining markets the actual purchase price per unit/share will be lower than the average of the ruling prices at which one bought.

Eliminate the risk of poor investment timing

"The biggest advantage of this strategy is that it eliminates the risk of poor investment timing, that is, investing a lump sum when the market is at or close to a peak," says Du Plessis. An investor who invested a lump sum in the local stock market (FTSE/JSE All Share Index) on 31 July 2008 would be showing a loss of 9.4 percent exactly a year later.

A recent study conducted by Plexus Asset Management reveals that that less than 22 percent of the 108 domestic equity unit trusts achieved positive returns over the year ended 31 July 2009. A total of 40 of the 85 funds that yielded negative returns for the year underperformed the FTSE/JSE All Share Index, achieving returns exceeding -9.4 percent. "Those who invested a lump sum a year ago and are showing any profit now should count themselves lucky," says Du Plessis.

If only I had rand cost averaged...

"However, the results are quite different for investors who had opted for a rand cost averaging strategy," says Du Plessis. "Had a lump sum been phased in over 12 months from 31 July 2008, not one of the 108 equity funds would have cost the investor money."

Rand cost averaging can be put to good use by investors with lump sums, or those who want to invest monthly amounts. "While small monthly contributions may not seem impressive at first glance, they enable investors to adopt the habit of saving and can really add up over the course of a lifetime due to the power of compounding," says Du Plessis. He encourages monthly investors to increase their contributions when markets are declining. "This will enhance the benefits of rand cost averaging by leaps and bounds," says Du Plessis.

A convenient and cost effective solution

Most collective investment companies facilitate rand cost averaging strategies for those who wish to invest lump sums. Investors will be encouraged to invest their lump sums in a money market fund, from which predetermined amounts are automatically invested monthly into the designated higher-risk funds. This is a convenient, cost-effective solution that mitigates concerns about investing a large sum at the wrong time.

"If markets are in expensive territory, one should choose a relatively long period over which to phase money into an equity fund. However, if markets are in relatively cheap territory, one should not take too long to phase the lump sum into an equity fund," advises Du Plessis.

Table A

The following is an example of a monthly investment of R1000 over six months. The average ruling price over the period was 124.17c per unit/share, but the actual price paid for the total number of units/shares over the six-month period was 120.36c (R6000/4985.19 units/shares).

Table B

The table below reflects the values of a R12 000 investment, invested as a lump sum in the best, worst and average performing funds after one year as at 31 July 2009, versus being phased in over the 12 months.

(Click here to learn what Personal Finance editor Kabous le Roux has to say on the topic of Rand cost averaging.)