Join our Stock Market News Group at GetPaidIndia on Telegram and WhatsApp.

This website is purely ACADEMIC in nature and NOT a stock market recommendation service or a tip provider. No live data or feeds are provided and all information is historic only. Information is provided for ease of understanding for the purpose of learning. Accuracy of definitions etc is not mantained. I am not a SEBI or IRDA registered.

Cost Averaging



From GetPaidIndia.com
Jump to:navigation, search

Hi All!

A Very Good Evening!!

Welcome to our Learning to Invest class

Lets do a quick recap of what we discussed yesterday.

Yesterday, we discussed about:

1. Investing and Trading

2. Stock market timings

3. What is long term investing

4. Preparing a daily budget for investing

I hope you understood all these topics.

We said yesterday that there are few methods of investing.

Being invested in the market is more important than missing / skipping few days by way of timing the market.

In otherwords, time spent in the market is more important than timing the market per se.

When investing, we need to have some specific strategy of putting money as well as booking profits.

Find or build an investment strategy that suits you the best.

Now that we decided to invest a certain amount of money, the next question we need to answer ourselves is:

Where (or in which company) should we invest in?

Remember that we should not invest in which ever stock we get tips about.

In the stock market, there are several not-so-good stocks and very few good stocks.

We should always invest in *fundamentally good companies* only!

As part of fundamental analysis, we

1. Try to understand the business of the company and ..

2. The performance of the industry in which the company works

The idea is that using financial analysis (FA), we should identify easily as to

1. Which companies to invest in, and,

2. Which companies not to invest in

So, by now we have two points:

1. How much to invest (daily budgeting)

2. Where to invest (fundamentally good companies)

Understood?

Now lets go to the next question

  • How to invest in stock markets for the long term?*

There are several investment methods being developed and used globally.

We shall focus on three important methods of investing are:

1. Dollar cost averaging or simply, Cost Averaging

2. Value averaging method.

3. Modified Value averaging method.

I will give an introduction to *Dollar cost averaging* today.

The *Cost Averaging* method is the simplest and most popular method of investing.

It does not require much logical thinking.

And it is very easy to implement.

You can determine how to invest using simple mathematics.

Remember that, as a Fundamental Analyst, you need to be reasonably good in arithmetics and should not be afraid of doing calculations.

We start with simple arithmetics such as additions, subtractions, multiplications and divisions

But as we progress, we might have to do complex calculations such as calculating CAGR etc.

Hence, alongside, we need basic working knowledge on using a spreadsheet software, such as MS Excel.

Using Excel, we will use several built in formulas to do calculations easily.

  • Assignment*

Look at your bank statement.

Check the average balance that you maintained in the last three months.

Determine how much surplus you had above the required minimum average balance.

Determine how much money you can safely allocate for investing in equities.

Please do this assignment by tomorrow's class.

This assignment will help you prepare your monthly and daily investment budget.

The idea behind this assignement is that you should invest only that money that you can part with after metting our your lifestyle expenses etc.

Sanchari Sir i hv a sip in ashok leylnd. Mnthly amount rs.2000. Should i divide d amount in daily basis?

@Sanchari: This is a good question. Ideally, if you can divide the amount on a daily basis and invest, it will be nice so that you can make use of the daily stock price volatility. However, understand that transacting involves brokerage charges etc. If you are investing using a discount broker who gives zero brokerage for delivery trades, go ahead and SIP it daily.

Contact me if you are not with a zero-brokerage plan and i can help you out.

@Aditya: Sir budget money should we invest every month in the same stock or each month a differnt script?

As part of Fundamental Analysis, we will build two portfolios:

1. Core portfolio with 5 stocks

2. Non-Core portfolio or satellite portfolio with 2 or 3 stocks.

We will invest in these 5 to 8 chosen stocks only.

How to invest? Using one of our three investing methods

Sir stoploss Kaise rakha jata hai vo bhi ek bar topic rakhna

@DipakDips: For a long term investor who works hard in identifying fundamentally good quality stocks, stop loss will depend on the individuals risk appetitle.

You can set a 25% stop loss for instance, if that is the extent of risk you can take.

If I am a high risk taker and if i feel that company fundamentals have not changed to go for a stop loss, i just ignore it.

We will discuss certain methods in our future classes as to how to book losses without taking much of a beating.

1. As *long term investors*, we invest in all market conditions irrespective of market moments

2. Financial analysis helps understand companies, businesses and their industries

3. We should always invest in fundamentally good companies only!

4. Daily Budgeting helps in investing on a daily basis

5. To determine the daily budget amount, we need to first identify our monthly budget

6. There are three important investing methods. Cost Averaging is the easiest and simplest of them all

Yesterday, i said about preparing a monthly budget and then determine the daily budget.

I gave you an assignement:

To determine your monthly investable budget and there by to determine your daily investment budget

If you prepare a daily invetment budget,

you can use that daily budgeted amount straight away into the Cost averaging method.

Now, lets get to our first investing method: The *Cost Averaging Method*

This method is called the *Dollar Cost Averaging Method* and was used first used in the US markets.

This method is popular in India with Mutual Funds where they call this method as *Systematic Investment Plan* or SIP.

However, the method was not popular in direct equity Investing in India because of cost overheads.

Almost all stock brokers till few days ago used to charge expensive brokerages.

Now that we are getting some nice and cheap discount brokers, this trend is catching up.

Prefer a discount broker over a full-service broker. Because there will be an impact of about 1% to 2% in your returns per year.

Understand that investing is an ongoing process.

It is not a single day or a one time activity.

It is not like: i buy today and wait for it for 1 year or 2 years for it to grow.

This method / strategy of investing is called *Buy and hold* strategy.

This worked well till few years ago.

But this method does not work in these days

.. because stock markets became more mature, they are more faster and dynamic compared to few years ago.

Long term investing is a disciplined and systematic activity.

You need to invest regularly in good quality stocks so as to take advantage of stock price movements.

For instance, we hear about success stories of Infosys, Wipro etc.

Companies like these have not become giants in few months or years.

It took them 15 to 20 years to build.

And 15 years ago, IT is a very little known business area.

For a country like India that believes in capital assets like factories and assets,

the service industry in the listed companies area is believed to be extremly risky.

During our analysis process, we should estimate if investing in a company is investment worthy or not?

This is very important because ..

if we invest in a good company, we can get not just profits, but build wealth.

So, with long term investing, our intention is to build wealth.

We have a concept of short term investing as well.

The aim of short term investing is to make *profits*

Hope u can make out the difference between *profit* and *wealth*!

However,

if we invest in bad compaines (because of poor analysis),

we make lossess..

and our wealth gets destoryed.

Understood?

So, it is important that we spend as much time as possible on understanding the company, its business etc. as a part of our fundamental analysis process.

Now, lets come back to our *Cost Averaging Method*

Let us take an example to understand this method.

A little mathematics is involved here. Do not worry. It is a very simple process.

Just relax, read and try to understand.

Now see this transaction.

Day 1 of investing

Transaction 1

Assume we identified a share whose CMP is Rs. 50.

CMP = Current Market Price i.e the price of the share when you are seeing it in the live market

Assume, from our yesterdays monthly budget, i arrived at my daily budget as Rs. 1000

i.e i will have to invest Rs. 1000 in my fundamentally stock today.

Our daily budget is Rs. 1000.

So we get Rs 1000 / Rs 50 = 20 shares

On Day 1, we make this Transaction 1

Understood this transaction?

Sound simple. Right?

Not much calculation involved.

No need to use much brain.

Let us see the components of this transaction?

1. Daily Capital amount

2. Current Market Price (CMP) of the stock

3. Determine the quantity of shares u get for the amount.

Now, after the first transaction, we just stop there. Nothing else to be done for that day.

Now lets go to Day 2

  • Day 2: Transaction 2:* On Day 2, assume that unfortunately the stock market is down.

Obviously, our share CMP would come down too.

Assume that the CMP of the share came to Rs. 40.

So, we buy Rs. 1000 / Rs. 40 = 25 shares

Understood the Transaction 2?

Now, compare both the transactions.

Rs. 1000 was invested on Day 1 and Day 2

i.e In both cases we invested same amount

.. but we got more shares in Transaction 2.

On Day 1, we got 20 shares but on Day 2, we got 25 shares.

So,

when markets goes down,

we are getting more shares for the same amount of money!

So market going down can be taken as advantage!

Now tell me, should a long term investor should worry about markets going down?

Generally, long term investors take it as an advantage while traders will have to face the problem if they have not traded right.

Understood ?

So, a long term investor actually dosent feel bad about markets going down or a correction.

Rather, he sees and tries to use the opportunity.

However, there are some conditions!

Provided, of course, that,

1. The shares we are investing in, are of *good quality*

2. We have money to invest in *both good and bad times*.

3. Invest the *same amount of money* on all days

Now, can u understand the importance of calculating our daily investment budget?

If you properly determine your cash budget, you will not be out of money on any day.

You can participate in the market in all days.

Of course, there is no easy way to predict market moments.

This is why, we generally *do not attempt to even time the market*.

We stay in the market at all times but with small daily budgeted money.

Every day, when markets go down, we automatically will be buying more quantity of shares.

Now lets go to Day 3

Transaction 3: Assume on day 3, market went up.

Lets assume our share CMP went to Rs. 55.

We buy Rs 1000 / Rs 55 = 18.8 ~ 18 shares.

So when markets go up, we are automatically buying smaller quantity of the share.

But the same Rs. 1000 in all the three cases.

Important point to remember:

In cost averaging:

1. When market goes up, we automatically get low quantity

2. When market goes down, we automatically get more quantity

.. even when we invested the same amount in both market conditions.

As i said earlier, we will have to be in markets in good and bad days by long-only investing.

So, by now, we learnt two more concepts:

1. Preparing daily budget for investing

2. Dollar cost averaging method

If you closely follow the above example,

In 3 days, we invested Rs 3000 (i.e Rs.1000 + 1000 + 1000)

and got 20 + 25 + 18 = 63 shares.

Our avg cost is Rs. 3000 / 63 = Rs 47.6 = Rs 48 per share

So, instead of buying Rs. 3000 worth of shares on a single day,

what i did is, i have spread the investment on three days.

In our example, we are saying we shd invest in the same share on all the days.

The method we just discussed called is called *Cost Averaging*!

Because the cost of the share gets averaged with each transaction happening.

In fact, this single method is sufficient to be part successful in long term investing !

Those who are familiar with mutual funds can correlate this method to SIP.

This is one reason why MFs are more popular and bring consistent profits while retail direct equity investors struggle

  • Assignment 2*

Assume my daily buget is Rs. 1000

I want to invest in a fundamentally good share whose CMP in the last 10 days is as follows:

98, 96, 94, 90, 85, 88, 92, 97, 95, 96

How many shares in total will i get at the end?

What will be the average cost of the shares?

Do this work tonight or tomorrow

Message me personally with your answer

Do not post answers to any of our assignments in the group!

I hope the assignment question is clear.

Remember, some of the assignments will look dead simple and silly. But believe me, take a pencil and do it. It works wonders and makes you think more about the concept.

Question:

Sir averaging not advisable in stocks investment?

Averaging is ok as long as the stock is fundamentally good.

If the stock is fundamentally bad, it works negative and opposite and hence might not be the preferred method of investing.

Question:

In MF it takes the ending NAV of the day... In equity stock can SIP be configured to happen at various points of time each day?

No. I am not aware of a broker who can put orders automatically at various periods of time.

The closest to your requirement is trigger order but that considers price of stock and not time.

What is advised for CA? Time? Opening time? Closing time?

For Cost Averaging (CA), any time and price during the day is okay.

There is no need to look charts, graphs, read news etc.

This transaction hardly takes 5 minutes.

If i am busy in office all day, i can do it during the lunch break !

Question:

When we have to place these buy orders since we have uc and lc price and we will buy in market order. wat u suggest us wat will be the best time to place order

If a stock hits UCs and LCs, it might not be that strong fundamentally.

This is because it is prone to easy manipulation by market participants.

.. and that there is too much of free flot in the market and no single strong hand to control it.

Such companies might be risky.

Question:

What if there's some event which can affect the price in either way... Should the CA strategy consider its effect?

Why not?

Cost averaging averages our overall holding and makes our average price move towards the CMP of the stock with each transaction.

Long term investors generally do not have to worry about daily price moments, either ways.

Change in fundaments of the company and industry are what they have to worry about.

Question:

Let's say a policy change is announced. That's quite possible with quality stocks right?

CA will take care of it over a period of time.

When an adverse change in the policy comes, a company with good management will immediately make changes internally to overcome the hurdle.

There will be negative impact in the stock for about a quarter or so but i think good companies will make a way out and start performin well in the long term again.

This is why promoter and management pedigree is an important consideration in our analysis.

One of our friend asked:

Let's I want to buy any company's shares of 25000/- amount.how I can distribute my money more safely. Ie .in 10 equal parts or more parts

Answer:

There is no hurry to buy shares of companies. We are long term investors.

As i said, i a month, we will have 25 trading sessions.

So, treat Rs 25k as our monthly budget.

Rs. 25k / 25 trading sessions = Rs 1k per day

So invest Rs. 1k in that share per day.

👍 what are the triggers which could totally stop the CA? triggers as to when to stop investing

Too complex to answer at this stage. But our future sessions will automatically answer to the question ;)

Question:

Not investing in general but CA in a paticular stock. Your personal experience where you had to stop the investing in a particular stock?

I would stop in a slow and gradual manner when the stock overweights in my portfolio.

Say, if the stock reached my targeted maximum allocation in the pf

  • Question to think.*

Remember the Cost Averaging method?

Assume my daily budget for investing is Rs. 500

But today, out of excitement, i bought more shares .. around Rs. 1000 worth.

Now what to do?

There are two things one can do:

1. Stop investing for the next day

2. Reduce the daily investment amount to, say, Rs 400 till the situation comes to normal.

An interesting video explaining the concept of Dollar Cost Averaging https://www.youtube.com/watch?v=dx9Kp3A4j8Y