Does peso cost averaging make sense?
Q: I have extra funds that I plan to invest in the stock market. My friend told me that buying slowly using peso cost averaging is the best way to make money in stocks. Is it true?—Karen Canceran by e-mail
A: Peso cost averaging is one good way to save money in investing regularly in stocks. The philosophy behind this method is “if you buy a particular stock on a regular basis, say every month, with an equal amount of cash each time, you will automatically buy fewer shares when the stock price is high and more shares when the stock price is low.”
By following this technique, you will somehow be able to control your risk because the tendency to buy more shares when the share price falls will enable you to lower your average cost. If you hold on to this discipline, your investment will pay off when the share price improves above your cost.
How effective is peso cost averaging? Let’s simulate using historical actual data on selected blue-chip stocks. Assume that there are no transactions and you have a budget of P10,000 to invest in a blue-chip stock every end of the month starting January of 2009 until the present. If you have invested in PLDT, you would have an average cost per share of P2,295 by now, which gives you a return of 42 percent at current market price.
Similarly, if you have invested in other blue chips following the same assumption, you would also have earned big returns by now. At current prices, your investment portfolio would have increased in value by 25 percent from Meralco, 37 percent from SM Prime, 35 percent from Metrobank, 107 percent from Ayala Land, 163 percent from Megaworld and 534 percent from Universal Robina.
While this strategy may look appealing, it may not be useful to everyone, especially for those who want to make the most of their investment. The peso cost averaging maybe ideal for people who don’t have enough savings to build an investment portfolio in the stock market. People who are new to stocks and do not have time to monitor their investment daily may also be ideal users of this technique. They can use this as a form of discipline for automatic savings and investment.
Let’s say you can only afford to set aside P5,000 from your monthly income and you decide to invest this in stocks. If you have invested in the stock of Jollibee every end of the month beginning 2009, you would have invested total of P350,000 by now. But you will be glad to know that the value of this savings at current market price has already grown to P787,000, a return of 127 percent.
But if you have the cash to invest in stocks and want to maximize your returns on investment, the peso cost averaging may not be your ideal strategy. Instead, you can simply do lump sum investing where you put your money in stocks in one time deal fashion. This strategy gives you returns many times more superior than the peso cost averaging. Let’s say you invested your money in lump sum in PLDT by the end of January of 2009. At current market price, this would have already grown by 57 percent, 15 percentage points higher than peso cost averaging.
If you are not yet convinced, you may want to know what would happen to the other blue chips if you used the lump sum investing strategy. Your investments by now would have increased by 276 percent from Meralco, 131 percent from SM Prime, 249 percent from Metrobank, 426 percent from Ayala Land, 736 percent from Megaworld and 2,514 percent from Universal Robina. Based on these returns, it is very clear that lump sum investing is more profitable by ratio of four to five times than peso cost averaging.
Note that when you invest in lump sum, you don’t need to use your entire investment budget into one transaction. You can manage your buying by timing your execution in several transactions at different prices and complete it in few days. Your objective is to get the lowest average price possible. As a guide, it will be helpful if you can use historical charts for reference.
While lump sum investing is far greater than peso cost averaging as shown in the historical simulations, let’s not forget that the sample used from 2009 to the present was in a market bull run scenario.
Peso cost averaging does better when the general market is on major downtrend. The losses are lower because of the averaging as compared to lump sum investing. But then again, this happens only when there is serious market bear run. In fact, for the past 14 years since year 2000, peso cost averaging beat lump sum investing 28 percent of the time.
It does not make sense to use peso cost averaging if you have the extra funds now to invest in stocks. This is simply because this strategy will limit your ability to maximize your returns. For example, when you are already committed to peso cost averaging, you will not be as flexible as lump sum investor if you want to switch stocks or reduce investment allocation should there be any fundamental changes in the market outlook.
Peso cost averaging makes sense for people with lower risk tolerance who want to leverage the stock market as a form of savings to get higher returns. Invest in stocks that have solid fundamentals and reliable as this strategy involves long-term commitment.
Henry Ong is a registered financial planner of RFP Philippines. To learn more about stock analysis for investment, attend our Accredited Financial Analyst (AFA) program on Nov. 8-29. To inquire, e-mail at [email protected] or text <name><email><AFA> at 0917-3464126.
