If you have ₱100,000 today, how would you invest it to earn passive income? Put it all in one-time big-time or divide it up in smaller investment amount? Which is better, lump sum or peso cost averaging strategy?
This is one of the questions I came across on social media. I’ve been taught about the benefits of peso cost averaging (PCA) and for the longest time, I hold onto it as one of the strategies that’s beyond question. In this article, I’m going to revisit this. I would be using the historical price of Jollibee Foods Corporation and FMETF stock, the exchange traded fund that closely reflects the top 30 companies in the Philippines.
Peso cost averaging
Peso cost averaging is derived from the dollar cost averaging. It is a strategy where instead of putting up huge capital and investing it into the stocks or investment funds, your savings is portioned into smaller amounts and invested in a periodic regularity.
It is a strategy born out of two factors. One, people especially those who are new to the market are affected by fear more than anything else. When they see that they’re losing money, they’d panic and redeem their shares. The result is that the paper loss, the loss that’s actually just on paper, become realized.
Peso cost averaging is a way to manage their reaction to risks. By buying shares at different schedules, they end up getting the average of high and low prices.
See the table for example for the historical closing price of Jollibee Foods Corporation in a span of six months, from March to August 2019. The price is quoted at the end of the first trading day of each month.
As you can see, you end up buying a higher price when you go for a lump sum strategy than when you utilize the peso cost averaging. The JFC stock price in March 1 was ₱309.00, but when you buy shares each first trading day every month you end up with an average price of ₱292.60.
But what I’ve shown you is actually half of the picture. You see, peso cost averaging is only a good strategy when you’re dealing with a falling stock. The year 2019 was not good for JFC because of its decreasing earnings many attributed to what they saw was its non-profitable acquisitions of Smashburger and then later Coffee Bean & Tea Leaf.
Peso cost averaging for rising stock
If you actually stretch the table from six months to 1 year, a different picture arises for JFC.
As you can see from the table above, the lump-sum strategy beats peso-cost averaging in a 1-year period. The opposite is true when looking at the past six months as you saw earlier, where the lump-sum strategy would put you in a losing position than peso-cost averaging.
And this is where the second factor comes in. There is no one in the world that can predict where the market would go—or the prices of any company shares for that matter.
Peso cost averaging is a way to be on the shallow end of the pool, so to speak, and ease into investments given that there is really no way to predict the direction of any share price or market movement.
It comes in handy as a means to spread out the risk that is inherent in investing in equities. As stock prices are volatile, they go up and down unpredictably, this strategy helps investors to actually get the average price over a period of time.
Lump sum strategy
However, studies have shown that over time lump sum actually gives more value than PCA in a rising market. In short, lump sum beats peso cost averaging in lessening the cost of purchasing stocks.
Why? The stock market has historically been on an upward trend. See this chart of the Philippine Stock Exchange index since 1988.
Three decades worth of data shows that, yes, the market may be volatile. But in the long run, you actually could ride on a gradually increasing value for your investments.
Lump sum with Jollibee
The difference becomes even clearer when we look at the historical price of Jollibee Foods Corporation. The earliest record of its stock price that I found was on January 4, 1995.
Now, right off the bat, we know that the stock has risen exponentially since its shares were listed on the stock exchange over two decades ago. So if you were lucky to subscribe to the company shares on January 4, 1995, the price was ₱8.64 a share.
|January 4, 1995||8.64||8.64|
|January 5, 1995||8.48|
|January 6, 1995||8.48|
|January 9, 1995||8.48|
|January 10, 1995||8.48|
|August 22, 2019||230.00|
|August 23, 2019||225.00|
As you can see, if you took the risk of investing in what was a relatively new company, then the lump sum strategy would work in your favor in the long term. Now, for peso-cost averaging, the average cost of acquiring a Jollibee share since 1995 is at ₱85.23 a share.
Just a caveat. Remember that when it was trading in the 90s, it was considered the new kid on the block, promising but untested, just all like companies that debuted in the stock market.
And if you look at the chart, its value only broke out of ₱50 in the middle of 2000s. So early investors that were able to subscribe at ₱8.64 had to wait for years before they could see their holdings rise in value.
Lump sum with FMETF stock
To better illustrate the difference between lump sum and peso cost averaging strategy, let’s look at the cost of buying stocks from First Metro Philippine Equity Exchange Traded Fund (FMETF), the only exchange traded fund in the country.
The reason that I picked FMETF is because it follows the stock index and thus mirrors its returns over time. It also has the least cost compared to other investment funds like mutual funds, UITF, PERA account, and variable universal life plans (VUL).
|December 2, 2013||88.26||88.26|
|January 2, 2014||84.73|
|February 3, 2014||85.61|
|March 3, 2014||90.03|
|April 1, 2014||92.67|
|August 23, 2019||118.20|
Looking back in time, FMETF stock was priced at ₱88.26 on December 2, 2013. By August 23, 2019, it’s valued ₱118.20 a share.
And if you’ve done lump sum investing back then, the cost of the share is ₱88.26.
Meanwhile, if you chose to go with peso-cost averaging and purchased the share every trading day since December 2, 2013, then it’s going to end up being more expensive. Your average cost is ₱108.79.
Frequently asked questions
Choosing a strategy to invest is a personal decision. My goal of creating this article was, as I said, to revisit the benefits of peso cost averaging.
Now, the way that the presentation was done might make you think that I’m advocating one strategy over another but that is far from the case. The only thing I advocate is to be critical about strategies, question them and try to come up with an answer the best way I can. What I can only do is to show, through research, how these strategies compare.
At the end of the day, whether you favor one than the other is a choice that only you can make.
From the research, it looks like it’s best to save first and then invest all in when the stock price/NAVPU/NAVPS is low. Is that true?
First of all, no one can predict prices of any stock and any of its derivative instruments like stocks, equities and index funds. So it’s quite difficult to say that at the moment that you invested one-time big time is when the price is the cheapest.
In a rising market—and not that I am saying that we’re in or we’re not in a rising market—the earlier you can commit capital the better is the potential for higher returns. You might not have to save, say, for a year and only invest if you’ve reached a certain big amount. And in a falling market, peso cost averaging would win out.
Which still brings us to the first statement: the unpredictability of equities.
So don’t be pressured to have a huge amount of money. The stock exchange or the investment company of your choice is open for anyone who’d like to invest as long as the trading floor is open.Tags