Friday, August 27, 2010

Cost Averaging

In a previous post I mentioned that I plan to invest P1000 every month in a mutual fund.  This is a strategy called "cost averaging".  This way, less shares are bought when prices are higher, and more shares are bought when prices are lower.

For example if the NAVPS for June 15 is P2.00, then P1000 buys 500 shares.
If the NAVPS for July 15 is P2.80, then P1000 buys 357 shares.
If the NAVPS for August 15 is P1.80, then P1000 buys 555 shares.

The total investment amount is P3000 and the total number of shares bought is 1412, for an average cost of P2.12 per share.  If you were psychic you could have just waited for August 15 and the price drop, but that's beyond the abilities of most people.

I've read arguments online that over the long term investing a lump sum beats cost averaging.  Meaning, over a long period of time (say three years or longer) you'd probably make more money by investing a lump sum rather than investing a small amount each month.  That's a good argument, but not everybody (including myself) has a large lump sum to investment.  Cost averaging allows ordinary investors to regularly invest without having to time or predict the market.

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