How to Take Advantage of the Global Economic Crisis through Cost Averaging (Part II of III)
Of course, the market can go either way. So instead of going up let’s say prices, this time around, went down. Let us see how the two investment styles will fare in a declining market scenario.
In Scenario 2 the mutual fund price drops from P10/share to P3/share. In the lump sum style of investing where P1,200 bought 120 shares at P10/share, the value would be P360 in December. Through PCA we were able to buy 266 shares because of the declining price and therefore will have an investment value of P798 in December. However, because of the big drop in the price of the mutual fund shares, bought styles lost money (-70% for lump sum; -34% for PCA) but PCA was able to minimize the loss.
So does this mean that PCA will always outperform lump sum investing? Not really! PCA is by no means a “cure-all” approach. In a market that steadily goes up, lump sum investing will generate more returns than PCA. In a third market scenario where the price steadily went up from P10/share to P20/share, PCA would have resulted to a purchase of only 82 shares. Therefore our investment value at P20/share (December) would have been P1,640 for PCA versus the P2,400 in the lump sum approach.
Hence, the ugly side of PCA is that there can be opportunity loss in extremely good (or bullish) markets.
Let us weigh our options. In good markets PCA can result to higher returns provided that there is some volatility in the prices that will enable us to buy more shares. With out the volatility, then we earn less (but we still earn). Aside from deposits, what other investments have zero volatility? – The answer is none. On the other hand, PCA reduces the risk and consequently the losses during bad markets. So in a nutshell PCA means reduced risk, with possibly higher returns, but not without possible opportunity loss. Sounds like a pretty good deal doesn’t it?
To be continued . . .
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You are most welcome Mark.
I want to say – thank you for this!
Depends on how you define aggressiveness. In my definition being aggressive means going into the market in a big way. Meaning investing a large proportion of your assets at the same time. PCA, on the other hand, is a much more conservative approach. You know that the levels are low but not where the bottom is exactly or when the market will reverse. So accumulating at a slow, regular pace reagrdless of the price levels, is something I would consider as a conservative approach to this type of market.
As for risk and volatility, well, they will always be there regardless of the market condition. The biggest losers nowadays are those that invested late in 2006 or early 2007 when the market was considered really bullish (market-flying season
During the bear market, I noticed that it’s more favorable to place an additional investment in a mutual fund like yours. Obviously, the NAVPS market value is quite low and a purchase during this market condition will translate a higher number of shares. In the other side of the coin, the possibility of losing the investment is imminent & simply hovering around because of the volatility of the market.
Honestly speaking, I’m just new in the world of this diversified saving/investing. I just want to ask some insights concerning the level of “aggressiveness” that I need to consider during this market-plummet season.
Thanks & more power