The universal law in stock investments is that you buy when prices are low and sell when prices are high. Sounds easy but then why do people still lose money in the stock market?
The reality is that stock prices are sometimes unpredictable due to factors such as economic, sectoral, political and global events that make it impossible to perfectly time the market. For investors unwilling to undergo the stress of timing the market and the labor of keeping abreast with market news, peso cost averaging or PCA can be a helpful strategy in growing your portfolio.
Peso cost averaging is an investment strategy wherein you buy securities such as stocks at regular intervals with the same amount of money over a long period of time. It works on the premise that you buy more shares when prices are low and you buy fewer shares when prices are high, reducing your risk exposure compared to making a single large investment in the wrong time.
What are the advantages?
Reduced worry — PCA spares investors from the stress that comes with timing the market. Some are frightened by volatility and often spend sleepless nights thinking about their stock positions when the market is down. PCA can take away the fear associated with inopportune investment.
Time efficient – Since PCA is an autopilot strategy, it gives investors more time to focus on other needs rather than spend their time watching and studying market movements.
Risk management – Let’s say you got lucky and inherited a huge amount of money. Since you understand that you cannot put everything in a regular savings account as you’ll eventually suffer losses due to inflation, you decide to invest in stocks. A couple of days after making your investment, the market suddenly plunges and instead of making a profit you end up losing money. PCA allows investors to spread the risk and slowly build their investment instead of plunging all their money all at once into an untimely investment.
What are the disadvantages?
In the field of stock investing, there is no single strategy that can guarantee a sure ticket to success. PCA is no exception. Although many investors appreciate and are attracted to peso cost averaging, the strategy also has its own flip side. Some criticisms associated with it are the following:
Rising stock prices – One disadvantage is when the stock you choose continually appreciates in value, making its price move consistently higher. In this event, investors may end up buying fewer shares, missing out on the opportunity of making one single huge investment when the stock price is still low.
Falling in love with the wrong company – Since PCA is pretty much automatic and relies on the idea that the purchase cost will average out, investors may fail to check on the current status of the company that they chose to invest in. Investors who think they can employ PCA with every stock of their liking may end up investing repeatedly in a stock that is worthless.
Transaction and other expenses – Another drawback is that PCA ignores transaction and other expenses such as taxes and broker’s commissions. Remember that transaction fees are imposed on every stock purchase. Since PCA is implemented by making consistent purchases, critics argue that it can dampen your actual investment returns.
Peso cost averaging has developed its own fan base and also naysayers. Followers believe this strategy offers them an easy way to invest minus the headache. Critics, on the other hand, argue that reducing the risk via PCA is just a myth created by people wanting to provide a “comfort blanket” for new investors.
The truth is that every investment strategy has its strengths and weaknesses. In the end, what really matters is if the strategy is aligned with your investment goals. Investing in the stock market can be both rewarding and heartbreaking at the same time. My advice is to always start with a goal and prepare an investment plan that includes a strategy that you understand and are comfortable with.
Jesi Bondoc is a Registered Financial Planner of RFP Philippines. He is the director of My Wealth MD and Partners, Inc. specializing in investment advisory. You can send money questions to firstname.lastname@example.org and they’ll be answered in his next article. For more info about the Registered Financial Planner program, e-mail email@example.com or text <name><e-mail> <RFP> at 0917-9689774.