Save & Learn » cost averaging http://www.save-and-learn.com Friendly, professional advice about saving and investing Wed, 05 Jan 2011 02:43:41 +0000 http://wordpress.org/?v=2.8.6 en hourly 1 How to Take Advantage of the Global Economic Crisis through Cost Averaging (Part III of III) http://www.save-and-learn.com/2009/03/28/article-3-how-to-take-advantage-of-the-global-economic-crisis-through-cost-averaging-part-iii-of-iii/ http://www.save-and-learn.com/2009/03/28/article-3-how-to-take-advantage-of-the-global-economic-crisis-through-cost-averaging-part-iii-of-iii/#comments Sat, 28 Mar 2009 07:22:54 +0000 Hector De Leon http://www.save-and-learn.com/?p=91 When can we say that our current losing position has improved?  Well there’s only one way to look at it, that is, if it is less negative if not positive.  So from a -15% to a -12% could be considered a 3% improvement in your current position.  Without doing anything the only way this can happen is if the price of your fund moves higher. 

 Can PCA Improve A Current Losing Position?

Earlier, we illustrated that PCA can reduce your average buying price as long as you are able to buy more shares at lower prices.  Therefore, PCA can improve your losing position by pulling the average buying prices below the original.  Hence, a 3% improvement can be attained by lowering your average price by 3%.

 Therefore, in principle, PCA can improve your current losing position.  But there is a catch though.  One, you need additional capital to pull this off.  And two, the additional amounts in total must be significant enough to even make a dent on your original lump sum investment. 

Say you invested P200,000 at the start of the year in a mutual fund that has a price per share (NAVPS) of P10.  Assuming no fees are charged, you were able to purchase 20,000 shares.  Unfortunately the price started going down for six straight months with no signs of reversing.  After six months you found your  investment losing by 20% as the price hit P8/share.  You decided to apply PCA for the second half of the year by investing P10,000 at the start of each month for the next six months.   

An evaluation of your investment strategy shows the following results:

slide6

  • You invested an additional P60,000 (+30%) to perform PCA.
  • With PCA you were able to add 7,966 shares (+40%) to you original 20,000 shares.
  • The result of being able to buy more shares at lower prices reduced your average price from P10/share to P9.29/share.
  • As a result of the lower average price, you managed to improve your overall investment performance from a -20% to -14% when the price ended the year at P8/share.

Aren’t you just throwing away good money after bad with PCA?

Not at all!  As illustrated earlier, PCA can work regardless of whether you are investing fresh funds or just adding to your currently losing investment to average down your price.  As mentioned earlier, PCA is not a perfect system.  It does have its pitfalls particularly in terms of opportunity losses.  Other approaches like Value Averaging may, perhaps, be more effective in certain market conditions.  However, if you are comfortable with a simple, easy-to-implement, and light-on-the-wallet type of approach then by all means do PCA and stick to it.

Warren Buffet suggested that the best holding period is forever.  For the short-term investors looking to make a fast buck, PCA is probably not your cup of tea.  But if you are a conservative, long-term investor, with a buy and hold strategy, this may just be the edge that you need to turn the current crisis into an opportunity to surpass your investment goals.

 

 

Note: There is a print link embedded within this post, please visit this post to print it. pixelstats trackingpixel]]> http://www.save-and-learn.com/2009/03/28/article-3-how-to-take-advantage-of-the-global-economic-crisis-through-cost-averaging-part-iii-of-iii/feed/ 0 How to Take Advantage of the Global Economic Crisis through Cost Averaging (Part II of III) http://www.save-and-learn.com/2009/03/17/how-to-take-advantage-of-the-global-economic-crisis-through-cost-averaging-part-ii-of-iii/ http://www.save-and-learn.com/2009/03/17/how-to-take-advantage-of-the-global-economic-crisis-through-cost-averaging-part-ii-of-iii/#comments Wed, 18 Mar 2009 01:01:46 +0000 Hector De Leon http://www.save-and-learn.com/?p=66 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.

slide2

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.

 slide32

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 . . .

 

Note: There is a print link embedded within this post, please visit this post to print it. pixelstats trackingpixel]]> http://www.save-and-learn.com/2009/03/17/how-to-take-advantage-of-the-global-economic-crisis-through-cost-averaging-part-ii-of-iii/feed/ 4 How to Take Advantage of the Global Economic Crisis through Cost Averaging (Part I of III) http://www.save-and-learn.com/2009/03/11/how-to-take-advantage-of-the-global-economic-crisis-through-cost-averaging-part-i-of-iii/ http://www.save-and-learn.com/2009/03/11/how-to-take-advantage-of-the-global-economic-crisis-through-cost-averaging-part-i-of-iii/#comments Thu, 12 Mar 2009 04:10:24 +0000 Hector De Leon http://www.save-and-learn.com/?p=49  In his book entitled Common Sense in Mutual Funds, John Bogle said “Excessive confidence in smooth seas can blind us to the risk of storms”.  Indeed, the bull run of the Philippine Stock Market that started in 2003 and lasted up to the middle of 2007 gave so much confidence to a lot of investors that many are still hanging on to positions that they bought at the historical highs of the PSEi and other investment vehicles. The question now for most of these investors is whether to cut their losses now or just wait for the market to turn around.  On the other hand, if the “cost averaging” approach can work so well during volatile market conditions as many investors contend, can it also work for investors that are already invested and currently losing?  Or is cost averaging simply for fresh funds getting into the markets for the first time?

What is Peso Cost Averaging (PCA)?

Peso-cost averaging (referred to as dollar cost averaging in the US and pound cost averaging in the UK for obvious reasons) is done by simply investing a fixed peso amount into your mutual fund (or other investment instrument) at pre-determined intervals (normally less than a year – monthly, quarterly, etc) . The amount of money invested at each interval remains the same over time, but the number of shares purchased varies based on the market value of the shares at the time of a purchase. When the markets are up, you buy fewer shares per peso invested due to the higher cost per share. When the markets are down, the situation is reversed and you purchase a greater of number of shares per peso invested. It’s a strategic way to invest because you buy more shares when the cost is low, so you get an average cost per share over time, meaning you don’t have to invest the time and effort to monitor market movements and strategically time your investments.  While the effectiveness of the concept has been debated on for decades now, even the skeptics agree that the PCA does really reduce risk and avoid the possibility of “investing all the money at a market high”.

To illustrate PCA let us consider three market scenarios and two investing styles per scenario.  The first investing style is the typical lump sum investing where you invest all your money on one price and wait for the price to go up.  The other style of course is PCA.  To simplify our calculations let us say that we have P1,200 to invest over a one year period. 

slide11

Price/Share  LUMP SUM  PCA
 Amount Invested  Shares Bought  Amount Invested  Shares Bought
JAN          10.00      1,200.00         120        100.00           10
FEB            9.00               -              -          100.00           11
MAR            8.00               -              -          100.00           13
APR            7.00               -              -          100.00           14
MAY            6.00               -              -          100.00           17
JUN            5.00               -              -          100.00           20
JUL            7.00               -              -          100.00           14
AUG            9.00               -              -          100.00           11
SEP          12.00               -              -          100.00             8
OCT          14.00               -              -          100.00             7
NOV          17.00               -              -          100.00             6
DEC          20.00               -              -          100.00             5
TOTALS      1,200.00         120     1,200.00         136
Weighted Ave. Buying Price P10.00/share P8.80/share

 In our first market scenario the price of the mutual fund moved from P10/share to P5/share and then to 20/share (over the one year period).  In lump sum investing, our P1,200 can purchase 120 shares at P10/sharein January.  Hence, at the price of P20/share in December, the 120 shares that we bought has a total value of P2,400.00. By applying PCA where we invest P100 at the start of each month (for 12 months) we can purchase 136 shares (16 more than the lump sum strategy).  This is similar to a lump sum investment of P1,200 at a lower weighted average price (P8.80/share). This means that the value of our investment in December at P20/share is P2,720.00.

To be continued …

 

 

 

Note: There is a print link embedded within this post, please visit this post to print it. pixelstats trackingpixel]]> http://www.save-and-learn.com/2009/03/11/how-to-take-advantage-of-the-global-economic-crisis-through-cost-averaging-part-i-of-iii/feed/ 6