Which is better? Peso Cost Averaging or Lump sum Investing?
If you have read my post UITFs & Mutual Funds: A beginner’s guide to investing in UITFs and its difference compared to Mutual Funds, then you have probably understood how these investments work and how they can help you design your investment portfolio even better.
Now you may ask, are there are any strategies/methods in investing so I can potentially maximize my gains and minimize my chances of losses?
Yes, there is.
Peso Cost Averaging versus Lump sum Investing: Which is better?
This post is focused more on Peso Cost Averaging which is one very simple but an effective strategy to minimize your risk in your investments.
But first, let us differentiate it from the Lump Sum investing and later on, I will show computations so you can understand the difference between the two better.
What is Lump Sum Investing & Peso Cost Averaging investing?
1. Lump Sum Investing
This is also called one-time investing where you put all your funds in a single placement only. The value of your investments equal to the present value of the units at the time of redemption.
2. Peso Cost Averaging investing (PCA)
This is a “passive” investing strategy, which requires systematically purchasing units with predetermined amounts at predetermined intervals over a long period of time. For beginning investors who don’t have the time or expertise to carefully study the stock market, then PCA is a good solution.
Successful investors have advised us that to become successful, one must do it regularly, to try to do it as often as every month. This is where PCA becomes helpful.
Take note that Peso Cost Averaging is a universal investment strategy and is not limited to Pesos.
It can also be used for other currencies such as Dollar Cost Averaging, Pound Cost averaging, and the like.
Note: While this post is framed with respect to Peso Cost Averaging using UITFs, I want you to remember that this method can also be used when investing in stocks and Mutual Funds.
If you’re directly investing in stocks, ask your stockbroker for any PCA plan. If you’re investing in MFs, ask your agent for this product.
How does Peso Cost Averaging Work?
Let’s dig deeper by studying this example below. Later on, we are going to compare the outcome with Lump sum.
For example, you are to invest P120,000.00 in a UITF and decided to use PCA as your investment strategy.
You are to invest P10,000 monthly, particularly every 10th of the month for 1 whole year starting Jan 10. Notice at the 2nd column, the NAVPU monthly changes. That’s because money and investments are too volatile and the NAVPU changes every day.
In the 3rd column (Amt invested), P10,000.00 is being invested regularly every 10th of the month. Since the NAVPU monthly changes, the number of units you can buy with P10,000 is not fixed, as seen in the 4th column (Units Purchased). The formula for this is Amt. Invested which is fixed at P10,000 divided by the NAVPU.
The 5th column shows the accumulated total amount of your investments to date (Total Amt Invested), while the 6th column shows the total no. of units you own to date (Total Units Owned.)
The 7th column shows the total value of your investments based on the NAVPU of that date. Like in October 10 2021, the total units owned to date is 4,866.67 units x P25 NAVPU = P121,666.67 which is the value of your entire investments if you redeem them on the said date.
The 8th column shows how much is your gains or losses if you will redeem your entire investments on that date . Notice that I have used green and red font to make it easier to identify. This is computed by subtracting the Total value of all your units in the 7th column, minus the Total Amount Invested in the 5th column . In this case, if you wish to redeem your investment on Oct 10, 2021 then you would have gained P21,666.67 (P121,666.67-P100,000.00)
Peso Cost Averaging versus Lump sum Investing Computations
Now let’s compare PCA with Lump sum investing.
Like mentioned earlier, lump sum is just a single placement of all your funds. So with the example above, instead of choosing PCA which is regularly investing P10,000 every 10th of the month until you reach P120,000, you decide to choose lump sum and invest the whole P120,000 all on Jan 10, 2021.
Total Amt invested : P120,000
NAVPU, Jan 10 2021: P30.00
NAVPU, Dec 10, 2021: P38.00
P120,000/ P30 = P4,000units
4000units X P38 = P152,000.00
P152,000 – P120,000 = P32,000 GAIN if you had chosen Lump Sum
But if you had chosen PCA, then you would have made an extra P87,600.00 for your pocket – that despite the NAVPU going sideways for the past months. Your gains using PCA are higher than your gains if you had chosen lump sum.
Notice that with using PCA, despite the losses on February, April to June, and September, the investment still ended up making an extra P87,600 on December. That’s because even when the market trend is going sideways, PCA can still provide you with an opportunity to earn profits
NOTE: This example is just a simplified version for you to be able to understand the ins and outs of PCA.
This example also favors PCA over lump sum. But the truth is, either PCA or Lump sum can out-perform each other.
There are instances where you gain more using Lump Sum. It really depends on the market at the time you invest, and the amount you will invest.
Advantages of Peso Cost Averaging
- You can start with a small amount instead of one big lump sum amount.
- When you invest at less cost, you invest with less risks because when spreading out your investments over a long period of time,you are lessening the risk of investing a large amount in a one-time investment at the WRONG TIME, which often leads to a huge loss.
- Like in our example above, even if at some months the whole market is down, at the end of the year, you can still come out ahead by earning gains.
- PCA will help you minimize risk while maximizing your profits because in real life, it is already a time-tested strategy.
Even though there are months where there are losses, as long as you don’t pull out your investments, you’re not really incurring any losses. This is what we call paper loss. Wait for the market to rise again and you’ll see the value of your investments rising too.
Disadvantages of Peso Cost Averaging
Some financial experts claim that PCA does not really reduce one’s exposure to market risks. Others claim that it is not a sound investment strategy because it often results to lower overall returns.
I believe that using PCA is better than doing NO INVESTMENT STRATEGY AT ALL, which is the case of what most people do when investing in other paper assets and the stock market.
A step-by- step guide on how to use Peso cost Averaging
- 1. Determine the amount you can use every interval
In our example, we used P10,000. For UITFs, you can go as low as P2,000.00 but the fund will only be rolling at every 10,000 allocation. It’s best to inquire with your bank before deciding on your desired amount.
- 2. Determine your interval or how often you can invest
In our example, we used monthly. But you can go as frequently as twice a month, monthly, every quarter, or even annually.
- 3. Invest the same amount regularly
Now that you’ve determined your desired amount and interval, do your best to follow your schedule.
If you’re not capable in visiting the bank every interval just to follow your schedule then you can ask the bank to invest it automatically for you. I personally use BDO’s EIP (Easy Investment Plan.) I’ve also posted on how I got to open one online. Yup! No bank physical appearance needed!
Read more about it here:
I chose to invest monthly, so every month, BDO deducts my savings account and automatically invests it to UITF. Other banks such as BPI and Eastwest bank have this kind of arrangement too.
Do what makes you comfortable. You can just invest regularly for a year then stop and let your money sleep for as long as you want.
- 4. When you think you’ve reached your financial objective, redeem your investments and enjoy the extra profits you’ve earned.
Final Thoughts of Peso Cost Averaging versus Lump sum
Lump Sum investing and PCA method will both give you money in the long run especially if your fund is participating with blue-chip companies.
Peso Cost Averaging is an investment strategy that allows you to passively invest equal amounts regularly without the need to closely monitor your investment. Because of this, you have more time to focus on other active ways to make more money like building your career, putting up your own business or even studying more paper assets that will help build your investment portfolio.
Now that you have that depth of understanding needed for you to invest, go ahead, and make that first step! Figure out if PCA or lump sum suits your risk tolerance better. With a little bit of effort and a lot of discipline, you can get started on investing right away.
Did you find this “peso cost averaging versus lump sum” guide helpful? If you did, please give it a Like and share this post. Thanks for reading and see you soon!
Ameena of The Thrifty Pinay