In this article from The IRS Report in October 2008, Chris Gilchrist talks about fund supermarkets.……

A simple way to ensure that you buy fear

Warren Buffett once observed that if you planned to eat a lot of hamburgers over the next ten years, you would not rejoice if the price of beef soared. Yet, he said, most investors who are in the process of accumulating financial assets tend to feel positive about investing and buy more shares when they rise in price, when in fact it's in their interests for share prices to stay low.

On that basis, those who are accumulating capital rather than spending it should feel happy about the opportunities the current stock market turmoil is presenting. But given our hard-wired hatred of losing money, which makes us very reluctant to buy when prices are falling, how do we discipline ourselves to buy?

Douglas Moffitt has a system he applies in his Rising Income Retirement Portfolio. But here i'm going to propose a simpler method that is also better suited to people with smaller amounts of capital - or indeed none at all.

My method is guaranteed to make you a profit over a period of 20 years or more and is virtually certain to make a profit over 10 years if you follow my method.

All you have to do is start a regular savings plan for a fixed monthly sum of £200 per month or more using a fund supermarket. If you do not already put £7,200 a year - the maximum - into an Individual Savings Account, then use a self-select ISA with a fund supermarket like FundsNetwork or Hargreaves Lansdown. If you already use your ISA limit, start a normal plan. Some stockbrokers now also offer regular investing facilities.

How can I be so sure that a regular savings plan will make you a profit? Because of the simple mathematics of cost averaging. Your fixed monthly sum buys more investments at low than high prices. Assuming a sufficient degree of volatility, that means you can make money even if market prices at the end of the perios are lower than at the start.

To illustrate this, assume John Smith put £10,000 into UK shares in October 2000 by buying an index-tracking fund. The FTSE 100 Index is down from 6,500 then to 5,300. but John has not lost 18%. In fact the cash-in value of his investment is £10,400 thanks to the reinvestment of dividends over the period. But contrast his position with that of his sister Jane, who started a £100 per month savings plan into the same index-tracking fund in October 2000. She has invested £9,600 so far and the cash-in value now is £11,000. That is a poor return on her money - just 4% annually, not allowing for interest earned on the money until it was invested - but at least she is in profit.

But suppose Jane had been bright enough to choose not an index-tracking fund but a fund run by a clearly exceptional fund manager: Fidelity Special Situations, managed by Anthony Bolton. In that case, the cash-in value of her plan would be £14,000, giving her an annualised return of 9% - and that over a period in which the UK market average is down nearly 20%. But now let's ask what would have happened if Jane had picked a really volatile fund for a regular savings plan. Now the numbers get a bit mind-boggling. Over a mere 5 years, a £100 per month saving into JPMorgan Emerging Markets fund would be worth £9,100 against an outlay of £6,000, an annual return of 16%. £100 per month for ten years into JPMorgan Natural Resources would have cost £12,000 and have a cash-in value today of £37,800 for an annual return of an astounding 20% - and that is after a 25% fall in the fund price! Over that same period, a regular savings plan in a UK index tracker fund would have earned a return of a pitiful 3.5% a year.

The last example is the key one. Back in 1998, few people would have picked natural resources as a likely winner over the next decade. And in fact the sector only took off after 2002, so you had four years to accumulate at low prices before the fund set off on a huge bull run.

So the key question is: How do you find a "sleeper" that will allow you to accumulate at low prices, and that then takes off to generate fabulous returns? The answer is that it has to be a specialist sector and fund. Given the huge recent returns, it's unlikely that natural resources will repeat the trick over the next decade. But here are a few specialists that could deliver a similar result.

• India. A huge and booming economy and a better legal and financial infrastructure than China. Jupiter India is down 10% since its February 2008 launch.
• Biotech. It's been the next big thing for a decade and has never quite made it ...yet. AXA Framlington Biotech was launched in 2001 and has creditable performance.
• Emerging markets. In ten years' time, China and India won't be emerging any more, but a new set of markets in Africa and South America may offer fast-growth opportunities. JPM Emerging Markets and Aberdeen Emerging Markets both have good records.
• Asian property. This is a sector that is developing at a cracking pace, and will probably move in a classic boom-and-bust cycle - ideal for long-term plan, providing you time your exit for a boom. First State Asian Property Securities fits the bill.
• The environment. We've seen one wave of boom-and-bust in alternative energy, but there will surely be another and bigger wave before long. Jupiter Ecology has been going for 20 years and manager Charlie Thomas knows his stuff.

With FundsNetwork, you can put as little as £50 per month into each fund, so with £600 per month - the maximum for an ISA - you could build a portfolio of these funds. I recommend a minimum of four higher-risk funds. If, Say, Two out of five come off you should do very well indeed.

And if you want to damp down the excitement a little, add a UK Equity Income Fund to the savings plan. Over 10 and 15 years, Invesco Perpetual Income has done almost as well as Fidelity Special Situations for regular savers - even though in capital terms it lags significantly - thanks to the benefit of reinvesting its high dividend income. And it is far less volatile than the other funds mentioned above.

Warren Buffett also once remarked that his job was to sell greed and buy fear. The great thing about regular savings plans is that you can be certain you will always buy more fear than greed.

You can see all of Chris Gilchrist’s articles at www.TheIRSReport.com.

Chris is the editor of The IRS Report every month.

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