Recurring investment in ETFs

We had been discussing how to invest your savings with stress free, but what if I don’t have savings? Sure, as we mentioned in the very beginning, you can put aside 10–20% of your monthly income and invest it in a certain ETFs on a recurring basis to achieve a combined goal of savings and investment.

Recurring investment into the same ETFs over a long period of time is similar to depositing your monthly income, but at the same time investing in a fund that gives you return for a long term. That said, it’s a go-to solution for investors who don’t have savings, and of course, who do have savings as well.

As we already know, it’s the worst thing to time the market. Since it’s likely impossible to know when it’s the good time to invest, why don’t you just keep buying the same ETFs on a recurring basis with a small amount, such as the day after your pay day, and let the market does its magic? Of course, it’s no magic. By doing so, you are actually lowering your risks, comparing to putting in a lump sum, by buying at high as well as low prices to average the cost of your investment, which brings you less rollercoaster concern.

It sounds easy, but the difficult part is whether you can consistently stick to the plan and put the money into your chosen ETFs at the designated date, even when the market is at all time high. To invest regularly as set, you probably have to turn off your emotion and just execute your plan no matter the market is going up or down. It sounds a bit cold, but the reward on sticking to such a plan can be significant, as it helps you avoid being too positive on the market and buying at high, or being too negative on the market to miss an opportunity to get in. At the end of the day, your acquisition cost is averaged out after all.

To help you better follow your investment plan, I have prepared a Recurring Investment Checklist (Download it here). Make sure you stick to the plan you create for yourself.

Let’s see below a simulated example on the investment cost over a 3-quarter period.

In the first 3 quarters of the year, the quotes of this ‘fake’ ETF moves up and down as shown in the chart. During the period, you keep putting €100 from your monthly income into the fund for 9 times. From the first sight of the chart, it seems that the average cost of your investment is €1. But is it really that? Not 100%. Let’s look further.

Acquisition/investment cost= total investment/total share acquired. You invested in total for 1052 shares with a total cost of €900. So your investment cost is not the market price of €1 but €0.86 per share, you have made some killing profit here- your acquisition cost is lower than the market. Over the period, the investment per month is fixed and the total investment is certain, so the changes in the quote/unit price determines the number of shares you can buy with the fixed investment. Hence, the lower the quote/unit price, the more shares you can buy with fixed investment value, which eventually average out your investment cost. This way of investment is also known as “dollarized cost averaging” (you can tell it was originated from the US by the name).

Now that we know how recurring investment works, does it mean that it can be applied to any ETF? Not exactly. ETFs are traded in the stock market, so they have a market price which can be over or under priced as it’s related to the supply and demand in the market.

One indicator to understand if an ETF is over or under priced is the PE (price-to-earnings) ratio. A higher PE ratio means investors are expecting higher earnings with the current price, so most of the time it indicates the ETF is overpriced, but it can also indicate higher growth opportunity. While a lower PE ratio suggests the ETF is traded lower than its value based on its earnings and is underpriced, which suggests being a good value investment for choice. It’s not a definitive indicator to judge if an ETF is a good target for recurring investment with high or low PE ratio. It depends more on if you are investing for growth opportunity or value. Personally I refer to the PE ratio when choosing ETFs tracking a certain indexes for their value. For the mainstream indexes (S&P 500, MSCI World, FTSE 100 etc), there’s usually no need to refer to the PE ratio but follow the general rules we discussed previously.

Here’s a list of ETFs with low PE ratios I discovered on ETF database, if you are interested in investing for value. Remember, even when choosing ETFs from this list, the general rules for choosing ETFs should still be followed.

Until then, stay calm and invest with peace.

I am curious about the power of money. I have been exploring personal finance and in search of the best ways to make money work for me.