THE Philippine Stock Exchange is by conventional definition in “correction” mode because it is down 10 percent from the recent and historic high. Note how we use the word “mode” in that sentence.
When a stock index, or share price moves down less than 10 percent, it is considered a “pullback” or “retracement.” A movement between 10 percent and 20 percent is a correction. And beyond that, it is considered in a “bear market.” Therefore, we could conceivably move down another 10 percent and it would still be considered a correction.
What should be your strategy at this point in the stock market cycle? It appears that every investment guru and expert in town is convinced that you should be “cost-averaging” your existing holdings. They see this as the best “strategy.” Cost-averaging in a declining trend is not an investment strategy. At best, it is an investment technique and not a very good one at that, based on every model analysis made.
However, if you want to make regular investments in the stock market as you would put some of your paycheck in the bank every month, that makes absolute sense. Take your extra P5,000 or P50,000 and put it into one of the professionally managed mutual funds available. That investment plan is one of the best things you can do for long-term wealth building.
But the idea of putting those same funds into an individual stock or even several issues on a regular schedule is wrong. Cost-average buying came from the idea that if you intend to invest, say P1 million, it was better to buy in tranches over a set period like one year to take advantage of the ups and downs of prices, even as the trend took the price higher. But even that has been shown to limit returns.
Statistical studies, which seem to be blasphemy to the cost-averaging believers, show that from January 1926 to December 2010 on the New York Stock Exchange, investing your money on one day yielded better results over every 20-year period than investing the same amount of money in equal chunks over 12 months. In the 70 percent of the time that investing everything all at once did better, it did better by 94 percent. When dollar-cost averaging did do better, it did so only by 77 percent. The same results happened for recent 10-year holding periods.
A strategy, whether in the stock market or in the battlefield, is designed for one important purpose: to answer as many as possible “If this/Then that” scenarios. “If the price goes down 10 percent, I will buy more” is a strategy. “If it’s the end of the month, I will buy more” is not. The cost-averagers always talk about anecdotal experiences where they bought at P10.00 and continued to buy all the way up to P100 and made a fortune. Everyone is a winner when prices are trending higher.
No cost-averaging enthusiast ever mentions a strategy along the lines of “If the price goes up to here, I will take a profit.” They are only concerned about continuing to buy over time regardless of the price or the direction. In fact, the experts seem to prefer falling prices to be able to buy more cheaply. The theory is that over a long enough period of time, prices will always go higher. Further, these same experts seem to have never had a losing trade. What they never mention is the situation when they are holding losing positions.
Buying more shares as the price goes higher makes perfect sense. But at some level you must take the profit. The cost-averaging group says that their strategy is based on continuous buying of increasing corporate value. That does not make sense.
The Price-Earnings-Ratio (PER) shows the relationship of company profits to share price. The PER of the top 500 issues on the New York Stock Exchange has varied from 70 in 2009 to 15 in 2012 to the current 20. Share price does not always accurately reflect corporate fundamentals.
Your stock-market strategy must include at least two If this/Then that scenarios. If the stock goes to this price, I will take a profit. If the price goes down to here, I will take a loss.” How you decide that either through corporate or price analysis really does not matter.
Gregg Fisher is president and CEO of Gerstein Fisher investment company and the 44-year-old manager of its global large-cap investment fund, whose current performance ranked 4th out of 296 peer funds. Fisher wrote this in the New York Times in 2011: “Dollar-cost averaging’s greatest value is to get people comfortable investing. The rational investor would not do it because it doesn’t make any sense, but we’re not rational.” I wonder which of our local gurus he has been talking to.
This article originally appeared at BUSINESS MIRROR by JOHN MANGUN
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