It is probably one of the most common investing strategies many would recommend. For this week, let’s revisit this strategy and look at how this strategy can help you meet your investment goals.
What is peso cost averaging?
It is an investment strategy used in either stock investing or pooled fund investment (mutual funds, UITFs). It is called as such because in this strategy, investment is being made in regular intervals, regardless of the price of the stock or the current value of the fund. Whether the fund or stock is at P120/share last month or P100/share this month, investor buys more shares. If the price moves to P150/share next month, it doesn’t matter. He/she understands that he is investing not because the price is high or low current value, but the rationale behind regularly investing is that he believes in the potential of the stock or fund. So for investors doing peso cost averaging, the current value at the time of making the investment holds little importance because what matters is the potential price of the stock or fund in the future.
Why do you do this strategy?
There are a couple of strong reasons why you are doing this strategy. First is that you think the company or the fund will grow in the next 10 years. So if it is a stock of a company and after doing due diligence, you have assessed that the company would grow. If you are investing in mutual funds or UITF, you see growth in the companies in which the funds are invested. Secondly, the reason you are using this strategy is that you are investing for the long term. And by long term we are looking at 10 years at least.
Are there risks in following this strategy?
Like any other investment strategy, there are risks associated with peso cost averaging. But since you are regularly making investments, your risks are somehow minimized, especially in the short term. But you have to understand that on the other side of the risks is the return. And if you apply the rule of risk and return, the lower risk to take, the lower the potential return you get.
How are risks minimized?
I will try and illustrate without making your head spin: in January 2016 you invested P1,000 and bought 10 shares of index fund at 100/share. In February 2016 the same index fund fell to P90/share. This means the initial P1,000 you invested is now worth just P900 (10 shares x P90). At this time you invest another P1,000 (11 shares) to make your total investment P2,000 (21 shares). In March 2016, the fund further drops to P85/share.
Your P2,000 investment is now priced at only P1,785. Making another P1,000 (12 shares) investment will get you to P3,000 total for 33 total shares. Now, because of volatility in April, price went back up to P92/share, getting your current investment up at P3,036. Since you invested at the P85 and P90 price points, you didn’t need for the price to reach P100/share to make a return.
Hopefully with the illustration above you get a better understanding of how peso cost averaging works. Knowing and understanding investing strategies already lowers your risk in any investment. Too often many people invest without understanding what they are getting into and that is the biggest risk you can take.
Jeremy Jessley Tan is a Registered Financial Planner of RFP Philippines. Attend the 1st Millionaire Investor Bootcamp this March 2017. To register, e-mail firstname.lastname@example.org or text <name><e-mail><MIB> at 0917-9689774.