Does Peso-Cost Averaging Really Work?

Below is an article taken from Insular Life giving some useful insights about Peso-Cost Averaging [Related articles here : The Easy Way of Investing & How to earn even with falling stocks??!]

This is still part of the series giving you several strategies that have been established throughout the history.

As you've probably (and yo should've) realized by now, there should be no strategy good for everyone as each person has different personality, and thus plans and time-horizon. It's basically pointless to ask and seek an advice from someone who's trading short-term if in the first you're banking long-term. I urge you to try out each of this strategy yourself and find one that works for you and for your goals.

Speaking of ehem, ehem, goals:

"Mag iinvest ako para sa education ng anak ko"

Biglang bumagsak ang market, nagreredeem na ng pera.

Bakit? mag eenroll na anak mo?"

-Rex Mendoza

Set your goals & invest according to it. This will save you from much headaches (and give you time to increase your cashflow instead!)

Happy Investing!

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Does Peso-Cost Averaging Really Work? By Efren Ll. Cruz,

A lot of people are being enticed to invest directly in the stock market especially now that the Philippine Stock Exchange Composite Index (PSEi) has reached unchartered territory. And with the economy also posting significant gains, it seems that that PSEi is still headed for the stars.

A school of thought, however, proposes that while investing in the stock market is far superior over the long-run than investing in fixed income instruments, it would be advisable to just invest a fixed amount periodically. This is called Peso-cost averaging (PCA), with the currency changing depending on what you are investing in (i.e. the strategy becomes Dollar-cost averaging if you invest in Dollar denominated instruments).

To see if PCA really works, let’s apply backtesting using the historical data on the PSEi. Based on the research of my company, the Personal Finance Advisers Philippines Corporation (PFA), investing in the PSEi would have produced the following returns:

Source: Philippine Stock Exchange

*assumes investment of Php100,000 at the end of each year

**up to November 29, 2012

You may be tempted to say that investing one time reaps the most rewards as shown in the simple average column. But simple average is deceiving in that it assumes that all the money you can and need to invest will be invested at one time.

Not very many people have the capacity to invest all they need to in one go. Moreover, investing all at once ignores the risk in not diversifying through time. No stock market moves in an upward straight line. This is because, as Jesse Livermore (the world’s greatest stock trader) once pointed out,

“Wall Street never changes, the pockets change, the suckers change, the stocks change, but Wall Street never changes, because human nature never changes.”

Livermore said that the FGHIs of investing, (i.e. fear, greed, hope and ignorance) periodically pull down the markets. The pull can be gentle like in a price correction or be a violent tug like in a stock market crash. History is replete with evidence of crashes from the Tulip and Bulb craze in 1634 to the Great Depression in 1929, to the Asian Financial Crisis in 1989, to the Dotcom Bubble in 2000 , and to the Global Financial Crisis in 2008.

Will there be financial crises again in the future? Most definitely! Ignoring this predisposition of markets foregoes opportunities in investing at cheaper levels, as what always happens during crises.

Another deceiving thing with simple interest is that it does not give the effective return. The annual compounded return is the better measure of effective return. And as can be seen from the previous table, investing over the long-term, especially over 25 years may not seem all that great.

So if most cannot invest all they need to invest in one go and, even if they did, would be foregoing valuable opportunities to buy cheaper, what should be the strategy? The better way is to do PCA of index component stocks. And as shown in the earlier table, PCA investing, with the exception of the 1-year measure, outperforms one-time investing in all other measures.

The other advantage with PCA is that excessive stress from investing is avoided through automatic investing rather than in timing the market. Excessive stress is one of the major causes of heart disease and no amount of money is worth chasing after if it comes at the price of high stress levels. Believe you me, my kidney function was cut in half during the Asian financial crisis when I was still managing funds.

So doing PCA on index component stocks works. And if you don’t have even the time to invest under this strategy, because of the details of having to rebalance your portfolio to match that of the PSEi, simply invest in stock index funds.

Want the stress-free way to financial freedom. Do PCA.

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As the old cliche goes, Plan your trade and trade your plan.
PLAN to be a long-term investor; don't become one dahil nalaglag hawak mo.

Have fun investing (stress-free!),
Omeng

PS: In strategies like PCA, choosing the right stocks is more important than timing the market.

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