My Take On Cost Averaging

 

As many of you already know, the Philippine Stock Exchange Index (PSEi) has been on a rampage, breaking record highs day after day after day. Value investors must be smiling right now since most of the stocks they bought one or two years ago are probably 3 or 5-baggers by now. Those who invested in the stock market via cost averaging (as recommended by Bro. Bo Sanchez in his free e-book) are probably smiling too. But some people might be asking: what the heck is cost averaging?

According to wikipedia, Cost Averaging is an investment strategy wherein money is invested in equal amounts regularly and periodically over specific time periods (such as P1,000 monthly) in a particular investment or portfolio. By doing so, more shares are purchased when prices are low and fewer shares are purchased when prices are high. The point of this is to lower the total average cost per share of the investment, giving the investor a lower overall cost for the shares purchased over time.
Like I said before, I am not a big fan of Cost Averaging. I must admit, though, that I would have used this investment strategy during the global economic recession. Bu that was 2008. Fast-forward to 2010, if I were asked right now if I would cost average my investments, I'd probably say 'No'. Here's why:
Cost averaging is feasible in any market, whether rising or falling. But while it is true that a person who invested Php120,000 in a top performing equity mutual fund in 2009 through cost averaging (10k per month) would have probably earned more than 100%, fact is, that person didn't maximize his potential ROI. As seen in the image below, cost averaging was not as feasible compared to a lump sum investment. Both strategies, however, did give decent returns because we currently are in a bull market.

On the other hand, when the market is going downhill, it may be wise to cost average an investment for the simple reason that we do not know when a market hits its bottom. At the same time, we are able to mitigate the risk of buying too many shares at too high a price. As we can see in the theoretical scenario below, the total average cost per share of the investment was lowered significantly compared to a single lump sum investment. In this scenario, cost averaging was the more feasible investment strategy.

In a nutshell, money cost averaging is still feasible at any market. But in a bull market, doing so may not yield the maximum earning potential of your investment. In a bear market, however, cost averaging is a more favorable strategy. How about you? What's your take on cost averaging and other investment strategies? Let me know by dropping a comment below. Thanks! P.S. If you like this post, kindly use the share button above, or subscribe to Richardson Consulting. That's all for now. Happy investing everyone! =)