It’s pure pain to watch someone suffer from losing all his investments due to a falling market. What to do?
It’s too easy to say, just hold on because markets recover all the time. Curious Capitalist over at Time.com points that the best response is no response, but active investors know that once you lose all the bets, you waste so much of the capital that you can’t get in when real opportunities come up.
Last week, I spoke with several investment guys who espouse peso-cost averaging. The moneysmarts definition of that is “pikit-mata” investing, where you keep setting aside the same amount of money regularly — monthly or quarterly — whether the market is up or down.
The idea is you buy more when the market is down. While you buy fewer shares with the same amount of money as the market rises, those who promote this investing style says it all bunches out in the end to your favor. Meaning the average cost is lower than if you buy everything all in one go.
This is conventional wisdom that you’ll find in most investing books. But there are critics that say it’s not what it’s trumped up to be. If you got a big whopper of cash, for example, and the market is starting to come up from a downturn, why do you have to chop it all up to buy P5,000 worth of stocks each month? They also say its just a sales strategy to ferret out money from people that would rather not buy because the market is down.
Mathematically, peso-cost averaging doesn’t make sense when the market is going up. If you buy a big load of shares just before it goes up, naturally, you’ll make more money. Juanis Barredo, vice-president of CitisecOnline.com, pointed out that what you’ll have in this scenario is a big jackpot.
The problem is that striking gold is not as easy as it sounds. Barredo says for passive investors, peso-cost averaging works. MoneySmarts says if it gets you to invest money you would end up spending on restaurant dinners and shoes and whatnots, then why not?
Of course, this assumes you fully understand the nature of investing in stocks — earnings are never guaranteed and the higher returns are matched by equally high risks of loss.
Feast your eyes on this illustration on what happens with peso-cost averaging. Then watch out for my full-blown article next Monday in the Philippine Daily Inquirer.
July 5th, 2008 at 8:57 am
@GINA and ZACK
Good question, Gina. Zack’s answer is how CitisecOnline’s Barredo explained the strategy to me (wink). Are you doing peso-cost averaging with your mutual funds, Gina?
Zack, what are the stocks that could fit into a basket worth P10,000 for example? That would be interesting to know
Have a great weekend, guys
July 5th, 2008 at 12:16 am
@Gina
dollar/peso cost averaging is applicable to stocks.
you could buy MEGaworld right now for *about* P1140 depending on its current price + transaction costs. you could probably get about 4000 shares of MEG right now with P5000 budget. whereas when it was trading for P3-P4 you would probably only be able to nab 1000 shares.
the point is that the P5000 is to illustrate a FIXED budget for an individual every month so that you dont put all your eggs in one basket - catching-a-falling-knife-stock-picking. So lets say that MEG eventually trades at P5.50 and you only have a budget of P5000 - you obviously cant buy MEG because it exceeds your budget - therefore you avoid the risk of buying stocks that are too expensive (when the market is generally a little to high).
i think this is a sound strategy for people who do not wish (or simply lack the time) to read financial reports extensively nor wish to study a bit of technical analysis to hint at where the general market *may* be heading.
July 3rd, 2008 at 11:37 am
isn’t peso/dollar cost averaging applicable only on mutual funds and UITFs?
you can’t buy stock purely on a flat 5,000.
July 2nd, 2008 at 3:23 pm
@chat, i thought long and hard about your comment. i searched articles in NYTimes, Wall Street Journal, Financial Times, Washington Post, on stock market investing to study how they weave the disclaimer into their articles. I searched my soul again and again on whether I was espousing a get-rich-quick scheme because i hate people who do that. I realized that one, you definitely won’t be seeing any formal disclaimer on any newspaper the way investment companies do it (the long disclaimer at the bottom of any research report) for the purpose of style and because space is worth its weight in gold. But you will find that within the article are efforts to present both sides of the story (risk versus return). I have tried to explain both the opportunities for return as well as risks in using this strategy (losing all your capital). Still, I added a new paragraph just to make sure that it is clear enough that no one will misunderstand its meaning.
I appreciate that you took the time to point this out. Best regards.
July 2nd, 2008 at 3:16 pm
@starter boy, the supporters of peso-cost averaging says its particularly effective for mutual fund investing because you are already paying management fees so that your fund manager can manage the funds for you. that means you don’t have to time the market — because they are the experts who are supposed to do it. how does that sound to someone who lost 24%? really curious…