Since there are numerous Equity funds both from Trust Fund and Mutual Funds I will be using the Philippine Stock Exchange Index (PSEi) as my basis for these strategies. I will be comparing the Lump Sum Investment which is the benchmark with the Cost Averaging, Share Averaging, and Value Averaging.
Our scenario for these investment will be based on a 5 year historical data of the PSEi from October 2007 upto October 2012. I specifically choose Oct 2007 since this was the peak of the PSEi right before its crash. On October 2007 we have an initial capital of Php 300,000.00 which we plans to invest in equity funds. If we invested everything on October 2007, with the price of Php 3758.97 per share, our total shares would equate to 79.8091. I made a illustration on how our lump sum investment performed from October 2007 up to October 2012.
If we invested everything on October 2007 we would be at a loss until September 2010. If we held on until October 2012, our investment will be gaining Php130,562.10 which is approximately 43.52% of our investment. Since we invested our money right before the stock market crashed on 2007-2008 we needed time to recover our losses. It would have been a different scenario had we invested a year later at October 2008.
LUMP SUM INVESTMENT OCT 2008
Investing our money exactly a year later from the crash had a tremendous impact on our investment. If we were lucky during this period our Investment on October 2008 would have grown to Php829,520.93 which is a gain of Php529,520.93 or an approximate gain of 176.51%. Unfortunately for us no one can predict when the market will crash and investing your money on the basis of luck alone increases your risk of losing your money.
In order to reduce our risk in investing on equities at the wrong time we will be using three different investment strategies which will reduce the risk of loosing our investment. Our first investment strategy is the Cost Averaging.
Cost averaging is investing the same amount of small investment in a particular span of time. Since our illustration is in a span of 5 years we will be spreading our Php300,000 within this time frame. In our illustration below, we will be investing Php5,000 each month from October 2007 up to October 2012.
COST AVERAGING OCT 2007 - OCT 2012
COST AVERAGING OCT 2008 - OCT 2012
The downside of Cost Averaging is when we invested at the right time when the market is continually rising. As depicted on the illustration below when the market if consistently rising, spreading your investment will reduce the potential of earning more. If we compared the Lump Sum investment on October 2008 to the Cost Averaging on October 2008-2012, you will notice a huge difference on the gain attained by placing a lump sum investment at the right time. The timed lump sum investment attained a whopping 176.51% gain compared to the cost averaging which only managed to gain Php191,135.08 or 63.71% of the total investment.
As I mentioned earlier, the lump sum investment method is ideal if you are lucky enough to invest when the market is already at bottom price level. Investing and relying on luck is a whole lot riskier than using a strategy in your investments. The Cost Averaging method allows you to spread the risk on your investment without all the hassle of having to compute your next move. Since you will be investing the same amount regularly it is much easier to keep track and prepare your succeeding payments.
Another benefit of Cost averaging is that it allows you to invest in other more secured investments vehicles such as time deposits or bond funds. Since you already know when you will be needing the money in order to add to your equity portfolio, you can utilize the remaining money in secure investments. If you consider an annual 6% interest for the bond fund the effective monthly interest rate will be at 0.48676% per month.
BALANCE INVESTED IN BOND FUND
If you invest the remaining balance of your capital on bonds from October 2007 - October 2012, regularly redeeming Php5,000 every month. Your remaining capital will earn a total of Php52,347.61 at 6% annual interest rate. If you sum up your earning from your Cost Averaging Investment on Oct 2007-Oct 2012 which is Php202,299.58, This will bring you a total gain of Php247,647.19 which is an increase of 84.88% from your initial investment. Although it still doesn't come anywhere close to the results on the Lump Sum Investment on 2008, it performed a lot better compared to the Lump Sum Investment on 2007. The Cost Average method protected our Investment from the unpredictability of the market.
The Cost Averaging method is the simplest and most straight forward strategy in investing equity funds. In the event of another market crash, it dampen the loss of your investment. On the downside the Cost Averaging method will also restrict the potential gain when the market is rapidly rising. In the next couple of weeks I will be discussing the other methods of Equity Investments explaining the differences between these strategies and citing the advantages and disadvantages of these methods.