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Cost Averaging Method. Easy Investment Plan. Simulation of Regular Investing.

the timing effect in the investment is minimized since purchases are spread out. Supposedly, the time you buy (whether at a high or low) is no longer relevant since your average purchase price will tend to be lower than future values.

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You might have heard of it. Cost averaging method. Strategic averaging method (SAM) if you are a fan and member of Truly Rich Club (I am). Easy Investment Plan if you are a COL Financial user or a BDO UITF client.
So what’s it all about?

In General

Basic principle is that you invest a regular amount at a regular period whether in stock market or in UITF / mutual funds to take advantage of the price dips in the market. Monthly usually. After all, we know that the investment prices do not go up in a straight line. But as a whole, they do go up. Eventually. Or quickly.
With this regular investment, the timing effect in the investment is minimized since purchases are spread out. Supposedly, the time you buy (whether at a high or low) is no longer relevant since your average purchase price will tend to be lower than future values. The purchases on lows will negate or average down the purchases at high prices. This is advantageous as well to those who do not have the time and/or skill to monitor the markets and time their entry. Good practice for stock investors and not traders.
Simple Simulation: Stocks
Let us consider this actual stock, using its prices from May-12 to Mar-13. Graph is shown below:
CostAveragingGraph_zps1e563cda.jpg

 

CostAveragingGraph2_zps43ceef2c.jpg

Assuming same budget, if we invest regularly by buying one board lot regardless of stock price, we end up getting higher gains compared to just buying one time big time. Buying only at the start does not give one the opportunity to take advantage of the low prices from Jul12-Nov12. (This works as a general principle but of course there will be exceptional stocks movements and scenarios. But the question is, how often can we spot exceptional stocks and/or movements?)

Some more notes:
  • In stocks, there are board lots required as such lower prices but same investment amount does not mean you can buy more shares (one example online does not consider board lots tsk tsk). Unless you plan on buying odd-lots. So in general, cost-averaging impacts purchase price but not number of shares given the board lot rules.
  • More frequent buying makes one victim of higher transaction fees.
  • Nonetheless, in spite of higher fees, the regular investment still emerges with the better yield. Difference in this example may not be that much but for trends with deep corrections and recoveries, cost-averaging will be very effective (see below example).
  • Beside this saves you the emotional cost of trying to time your entry or worrying about the plunge in prices after you invested in May-12.


Better Simulation: UITF

Same exercise but this time for UITF. I think cost-averaging works better for UITF (or VUL) more than for stocks. Why is that?Because impact is not only on purchase price, but more so, it enables the investor to purchase more units at the same investment amount. Impact may not be significant based on below example, but in the long run, the more units you have determines the portfolio size, more than the price.

 

At same amount of Php55k, cost averaging can buy 12.35k units whereas buying one time big time only gives 12.09k units. In the long run, this 300 units difference can create a significant difference.Some notes:

  • Cost averaging can be more effective for investments that are units-based and not subject to board lots restrictions, such as mutual funds, UITF or variable unit-linked insurance.
  • Further, these types usually have no fees incurred for frequent transactions, hence frequent regular investing is not costly.
  • More units bought means more units can earn in the future. With this, both price appreciation and higher number of units contribute to better returns. 
Last Example

Just to drive the point. In the unfortunate incident that you decided to go “all in” with a stock that was very promising, like a blooming flower or lady. Then the market decided to dump it. Well I hope if you see this plunge you would have gotten out before it reached Php9 by May12. But if you did not have the time to check on the market again, sorry.

Exaggerated? Maybe yes, maybe not. Anyway, at the end of the day, it’s your money. I’ll guard mine
.

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About Geri (348 Articles)
Founder and main author. Husband, used-to-be-breadwinner, God-made multi-millionaire, employee, financial planner and adviser, investor, stocks trader, entrepreneur, agri-preneur, book author. Firm believer that all Pinoys deserve a richer life. Not a guru, but a forever student of the investments world, a work-in-progress.

2 Comments on Cost Averaging Method. Easy Investment Plan. Simulation of Regular Investing.

  1. I agree with you Anonymous. That is why in my tracking files, I already factor in anticipated selling fees in computing for the market value of my portfolio.

    Thanks for the comment!

    Like

  2. For small time players, fees will really hinder them from frequent trading since small funds will have small nominal gains in spite of big price appreciation %wise. This they have to consider in selling gains and taking profits.

    Like

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