DOLLAR COST AVERAGING
Monday, May 24, 2010
INVESTOR EDUCATION = WIN WITH DOLLAR / RUPEE COST AVERAGING
INVESTOR EDUCATION SERIES
DOLLAR COST AVERAGING
DOLLAR COST AVERAGING
(OR, RUPEE / POUND COST AVERAGING)
A GREAT WINNING TOOL
Stock market is not a stable Market.
Price Volatility is high in stock market, compared to other markets. Stock prices go up and down on every day that the market opens. Some times, the price of a particular stock goes up gradually, or in small jumps over a few days, weeks or even months. Then, there may be some short or long periods of corrections, when the stock price slides down.
Stocks traded in a market are lumped together under groups of stock Indices – like SENSEX, NIFTY, BANKEX, and so on. These groups of stocks , or indices, move up and down on a daily basis, based on their component stock prices.
The stock prices or the group prices called indices, move up or down depending on many market related factors and some non-market related factors.
We can list several such factors – company specific, Industry-specific, Country specific, Product-specific, and so on factors.
As management specialists say – there is only one thing constant in the world – and that is CHANGE. Continuous Change in all factors affecting stock prices is a reality that we must face.
What does this imply?
Changing Market prices of all stocks and their derivatives present before us – a big challenge, a big opportunity and also a big risk.
In such a volatile market, how do we determine (1) what are good stocks? (2) How do we determine attractive PRICES to BUY and (3) How do we determine attractive PRICES to SELL?
All stock investments are centered around these 3 questions. There are scientific approaches to answer these questions.
Picking GOOD STOCKS can be done through the value investing principles of Great Investors like Warren Buffet, George SOROS etc.
Find out the most successful investors in your country. Find out what they are investing in currently. Find out the fundamentals and technicals of those stocks, evaluate them, satisfy yourself and SELECT the most promising stocks among them.
In stock selection methods, I,like many investors, am a great FAN of Warren Buffet. There are scores of Books on Warren Buffet’s strategies. Read any one or more of them. Understand them thoroughly. Some of his Methods are also summarized in a few Posts in this BLOG also.
You will understand what are GROWTH STOCKS or VALUE STOCKS.
Never hurry to invest – without adequate analysis.
The market will not run away. A Growth stock remains so – even after you analyze it thoroughly.
The essence of the technique we are about to examine – i.e., DOLLAR COST AVERAGING - is precisely that.
You are going to take the GROWTH or VALUE of the stock – through out its GROWTH PERIOD.
Warren Buffet poses the question – how long shall I stay invested in a growth stock. He answers – forever. Which means, the opportunity to invest in good growth stocks is in fact – forever.
For the present – assume – you have zeroed in on a GROWTH STOCK. It has been growing consistently for the last 4-5 years, as per data you have verified. The company is under good, competent management.
You would have seen many analysts recommending, vaguely –It’s a good stock – buy on DIPS.
Suppose stock X is at a price of Rupees.1500 (or dollars, or pounds – according to your country). Now, you find, nobody is recommending the stock at current price on your favorite business TV channel. But, they are recommending that you BUY ON DIPS.
Your stock Broker may recommend that stock at current price – as long as the transaction is through him. They must survive on the commission that you pay, as Warren says. They ask you to BUY now. Your TV channel analyst says – BUY ON DIPS.
Suppose the stock corrects to X-5% due to some reasons. Now also, your TV channel very warmly recommends the stock on DIPS. Your broker wants you to BUY NOW.
Suppose the stock goes up to X + 5%. The same thing again. Broker says – buy now. Channel says – BUY on DIPS.
I am not saying all are in the same mould. No. Frank analysts, Brokers, investors and traders are available. But, the point I am trying to make here is – you must be the ANALYST FOR YOUR INVESTMENTS.
Many persons want to invest periodically some specific portion of their incomes – but don’t have the time to watch a large number of scrips or their derivatives. By popular experience, most investors agree that – it is difficult to predict the lowest or the highest points of price and the correct timing of buying and selling.
It is here, the concept of Dollar (Or, Rupee) Cost Averaging helps the long term investors very well. It is to be emphasized that this approach is suitable only for LONG TERM and reasonably disciplined investors, with periodical, investible sums of money.
Such investors must develop a habit of consistently investing a regular sum of money at regular periodical intervals in the particular growth stock selected by them through analysis of scientific value investing principles.
Such an approach can also be practiced for investing in Mutual funds, Exchange traded funds and other stock derivatives etc – if the investment is on long term basis.
In this Post, we will deal with dollar cost averaging in a growth stock.
Let us say you have selected a Growth stock on value Investing principles in 2007 . The Growth stock you selected is of , let us say – X Co. There are many Growth stocks that are growing at an average rate of growth of 10 percent per quarter. Selecting such stocks based on past 3-5 years experience is the first task.
You must fix a particular sum for investing in that stock, periodically. Let us say, you will invest $ (or Rs.)5,000/- once in every 3 months.
Based on your income stream, the investment can be made on monthly or even weekly basis.
Dollar/Rupee Cost Averaging Method of Investing implies the following:
(i) Amount invested is approximately the same each time – plus or Minus 5% to adjust for the very small shortfall or very small excess needed to adjust the extra share to be bought or left out.
(ii) Periodicity of purchase is same. However, in my view, you can vary the timing - to suit your income stream and the stock trend – by a week, this side or that side, to take advantage of any visible, temporary market trend.
(iii) Market price of such growth stocks may increase and decrease over a period of time in wave pattern – in sync with general market trend.
(iv) At the time of results – quarterly, annual etc – there could be bursts of activity in prices. We must anticipate them and adjust our timings to take advantage of them.
(v) We must study the results every quarter – to ensure that the growth stock continues to conform to our definition of Growth stock – that it continues to perform to our expectations. Even great Companies some times commit serious mistakes, which take considerable time to rectify.
(vi) You can do this with Investment in Individual stocks or mutual funds or Exchange traded funds and so on – as long as their earlier performance has been verified by you reasonably. We will of course, concentrate here on Individual Value / Growth stocks.
Let us look at a specific example :
A growth stock, with face value of Rs.10/- is available on 1-1-2008 at Rs.125. You have checked up all necessary parameters and decided to invest using the dollar cost averaging method.
Your investment proceeds in the fashion below :
DATE : AMOUNT INVESTED : Market price x No.of shares
01-01-2008 : Rs,5000/- : @Rs.125 x 40 shares
01-04-2008 : Rs.5000/- : @Rs.100 x 50 shares
01-07-2008 : Rs.5005/- : @Rs.143 x 35 shares
01-10-2008 : Rs.4980 : @Rs.166 x 30 shares
01-01-2009 : Rs.4956 : @Rs.177 x 28 shares
01-04-2009 : Rs.5000 : @Rs.200 x 25 shares
01-07-2009 : Rs,5016 : @Rs.228 x 22 shares
01-10-2009 : Rs.4884/- : @Rs.222 x 22 shares
01-01-2010 : Rs.4950 : @Rs.225 x 22 shares
01-04-2010 : Rs.4972 : @Rs.226 x 22 shares
TOTAL : Rs.49,763 : TOTAL : 296 shares
We have spent approximately the same amount of Rs.5000 at each quarter beginning and purchased the number of shares possible, of the same growth share, X , at the prevailing market rate.
Totally 296 shares are purchased at a total investment of Rs.49,763/- over 10 quarters. The arithmetical average price is : Rs.168.12. However, some people adopt the harmonic mean. We can even build into it time value of money.
Here, we have considered only the capital appreciation and not Dividends, Bonus/right shares etc, though at least dividends are possible as a normal feature of growth stocks.
While the cost price is Rs.49,763 for 296 shares, its current value at current price is Rs.66,896/-, yielding an appreciation of Rs.17,133, or 34.43 percent. You can always find growth stocks which give this yield, or more, over the long period.
We have taken a fairly stable period. But, if there are heavy corrections, the purchases made during those corrections will be at much lower prices and when the market returns to normal, your returns will be quite good. Your dollar / rupee costs are averaged.
Let us take a second scenario. Suppose, some one had a lump sum of Rs.50,000 to invest on 01-01-2008. He can invest in the growth stock X at the rate of Rs.125 and acquire 400 shares. Now in this 10 quarters it would appreciate to Rs.226 x 400 shares = 90,400/-, giving an absolute return of Rs.40,400/- or 80.8 percent return.
This way, using the DOLLAR / RUPEE COST AVERAGING METHOD, it is possible to beat the stock indices and inflation, and achieve excellent returns by any intelligent investor.
Remember, make your home work in selecting a good growth stock. That is all there is to it.
There may be times, when the financial performance of the company is to your expectations, but the price performance is not – due to some market related conditions.
You need not unduly worry about it and continue to invest at the lower prices, taking them as opportunities to INVEST.
How long should we invest in such growth stocks?
As long as we can. As long as the stock continues to be a healthy, growth stock. If at some point of time, you want to book some profits, you can, provided you have some better use for that money. Otherwise, like Warren Buffet says – let the investment continue permanently. You will not Regret it.
Put your eggs in the growth basket. Watch it grow. The RESULTS COULD BE FANTASTIC & UNBELIEVABLE.
You can modify and improve upon what I Have written, just as I have done my self to the concept in some parts of this Post.
Other Articles in CUSTOMER EDUCATION SERIES can be read at the following URLs :
1. 1. MONEY FASCINATES:
2. MARKET INVESTMENT : ESSENTIAL RULES FOR SUCCESS:
3. SELECTING A GOOD SCRIP FOR INVESTMENT
4. INVESTMENT STRATEGIES OF WARREN BUFFET: (5 ARTICLES)
6. WORDS OF WISDOM FROM WARREN BUFFET:
7. DOLLAR (RUPEE) COST AVERAGING : ( CURRENT BLOG POST)
8. PRICE TO EARNINGS RATIO :
9. GROWTH STOCKS vs VALUE STOCKS :
10. CANSLIM TECHNIQUE :
11. PRICE TO BOOK VALUE RATIO
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