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Mutual Funds: Money Cost Averaging Strategy


One thing is guaranteed in the market: it goes up and down. Thus in investing in mutual funds it is very important to know the risks involved. Yes we can lose money in mutual funds, but to minimize and manage the risk, one must constantly do additional investments and invest with a long-term horizon. 


This strategy is often called: Money cost averaging. How does this strategy work?
Money cost averaging in mutual funds
Money cost averaging in mutual funds
Money cost averaging is a strategy to systematically purchase shares of mutual funds (can also be applicable in stocks) to minimize investment risk in a fluctuating market. 

This strategy is very simple. A constant amount should be invested at a specific time interval (e.g. monthly) regardless of market condition. 

However, this strategy does not guarantee (as all other strategies) a profit or prevent loss thus it is important to consider one's ability to continue and stick with one's financial plan. 

For example, given the following details: 

Monthly Investment of 5,000
Investment Horizon: 6 months
And price per share fluctuating as shown in the table below: 
Example of money cost averaging simplified
Example of money cost averaging simplified
Looking at the table above, the total amount invested for 6 months is P30,000 and was able to accumulate a total of 900 shares. Now to get the current market value, we need to multiply the total number of shares and the current market price at month 6 which is P50.

Thus:
900 shares x P50.00 per share = P45,000!
So the total growth for the past 6 months is 50% of the total investment. 

If the person invested one-time, big-time on the first month: 

Total investment on month 1: P30,000
Number of shares bought: P30,000 / 100 = 300 shares
Current market value at month 6: 300 shares x P50.00 per share = P15,000!
The investor could have lost 50% of the total investment.

Now blowing this up: 
Using data from Bloomberg for Philequity Mutual Funds:
Philequity Fund Inc. Performance
Philequity Fund Inc. Performance (source: Bloomberg)
If the investor decides to do "one-time, big time" investment:
"One-time, Big-time" investment in Philequity Fund, Inc.
"One-time, Big-time" investment in Philequity Fund, Inc.
The investor's P800,000 becomes P841,923.24 as shown in the table above. 

But what if the investor decides to do "Money Cost Averaging."
Money cost averaging in Philequity Fund, Inc.
Money cost averaging in Philequity Fund, Inc.
Then, the investor's P800,000 in total contribution becomes P898,768.55.

This does not mean however, that the money cost averaging is better than the one-time investment. Example: 
Philequity Fund, Inc. 4 year performance
Philequity Fund, Inc. 4 year performance
If for the same data above you invested in Philequity Fund, Inc. last January 27, 2012. 
"One-time, Big-time" investment in Philequity Fund, Inc. sample 2
"One-time, Big-time" investment in Philequity Fund, Inc. sample 2
Your P800,000 becomes P1,296,997.68! 

Even if you do money cost averaging on that, you can not beat "one-time, big-time" investment when the time horizon is stretched to more than 3 to 5 years. 

Certainly, the money cost averaging strategy is a great strategy especially when you want to minimize and manage risks. It is also perfect when one can not invest a huge chunk of money one time. Though it may not be the best strategy to maximize returns, again, it all depends on your investment plan and investment goals. 

Stick to your financial goals and plans. 

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