Entrance strategy - A step by step approach
Summary: Many people have recently decided to start investing, perhaps to avoid the minimal return on a savings account, or to counter rising inflation. But how do you time your entrance into the markets when the markets are turbulent?
There is no perfect entrance strategy for every individual; your strategy will depend on your personal situation, your time horizon, and your willingness to take risks. However, a rules-based investment strategy can help all investors manage their risk during market volatility.
Diversification in your timing
Risk management is an important part of investing, as well as diversification, thinking long-term, and ensuring you aren’t investing beyond your means. Never start investing with 100% of your savings and try to think “long term”, which is not 6 months but rather 10 years.
Diversification with investing is often found in the form of ETFs, stock baskets that track an index. You can also apply this ‘diversification’ as you decide when to enter the markets.
This means you can either invest with a set amount of your money at one time, or you can invest a set amount gradually: in a planned, timed cadence (i.e. over the course of a few months). By taking the latter approach, you are diversifying your timing.
The strategy step by step
You are going to spread your purchases over time to depend as little as possible on timing the market perfectly.
First, divide the total amount of money you want to invest into a number of equal “parts”. This can be any amount you feel comfortable with: four parts, six, twelve, etc.
Next, make your first purchase of the ETFs with the first “part”.
Now you have your remaining parts (i.e. four), that will only be invested if one of the following triggers is met:
Trigger 1: time
The next investment (i.e. ¼) of the starting amount is at a set date you decide in advance (i.e. next month or next quarter). However, you may want to buy earlier, but only if you experience Trigger 2.
Trigger 2: lower price
Suppose your first purchase was 250 ETFs for €40 each. Then, one day you notice that the ETF is selling at a 10% lower price compared to your last purchase.
Trigger 2 occurs when you notice your original purchase is at a 10% lower price compared to your (last) purchase price.
You can place a Good Till Cancelled buy order at 10% lower than € 40: at € 36, then buy 277 ETFs for that amount of money.
This way, if the market dips, you know you will be a buyer at € 36. If this order is filled, you can immediately place the next purchase order that is 10% lower than € 36. In practice this will be a buy order for 309 ETFs @ € 32,40.
The 10% used in this example is not required. You can also decide to opt for 5% or 7.5% as a trigger, whatever you feel comfortable with.
What have you achieved
Now you have a rule-based entry strategy for building up your portfolio. This strategy prevents timing your purchase and emotional decisions.
In summary: it is determined in advance what you will buy and when. First, you decide on the number of parts you are going to divide your capital in. Then, you do your first purchase and for the following parts: either the trigger is 'time', or the trigger is a 10% lower price.
This strategy leads to a prudent build-up of your portfolio for a fair price, without the pressure and anxiety of timing everything perfectly.
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