VIEWS: 10 PAGES: 3 POSTED ON: 11/7/2009
Bottom When a security or market sinks to its lowest price level in a given time period, it means they have hit bottom. Whenever the markets plummet, people get excited about getting in, but they want to do so only after securities have bottomed out - when price levels begin a steady rise after hitting bottom. Since everyone wants to know when that will happen, CEOs, media types and analysts all try to forecast the upturn, which signifies that the bottom has indeed been established. Because no one wants to be the last to call the bottom in case price levels tank further, we are bombarded with confidence-building words from every level of industry, including the industry watchers, that prices are unlikely to continue their downward trend. Much of this commotion comes from the "buying on the dip" mentality left over from the previous bull market in the 1990s when many made a lot of money buying cheap at every dip and riding the recovery. On the other hand, investors in a bear market feel "things can't possibly get any worse" and that "logically" the market can only climb up. The technique is called rupee-cost averaging (also known in conventional terms as Dollar Cost Averaging), and it is one of the simplest and most useful investing techniques around. Rupee-Cost Averaging is simply putting a set amount of money each month into an investment such as a stock, index fund or mutual fund. Most banks will even set up a monthly automatic-withdrawals service. Rupee-Cost Averaging is also ideal for the investor who doesn't have that big lump sum at the start but can invest small amounts on a regular basis. Rupee Cost Averaging As an efficient tool The markets, even though they have bad days or even bad years, tend to go up over time during the past century, the Indian equity markets appreciated each year by a near 10% average. When you invest a set amount of your money each month, you buy fewer shares when the market is high and more shares when it's low. For example, your fixed investment might buy 10 shares when the price is low and only five shares when the price is higher. Rupee Cost Averaging therefore lessens the risk of investing a large amount in a single investment at the wrong time (i.e. at an inflated price), and in a falling market, the average cost per share becomes smaller and smaller. This lessening average cost per share will help you gain better overall profits as the market increases over the long term. Example Let's suppose that as an investor you just got a bonus and now have Rs.10,000 to invest. Instead of investing the lump sum into a mutual fund or stock, you decide to use dollarcost averaging and spread the investment out over several months by investing Rs.2,000 a month for the next five months. This averages the price over five months, so some months you may buy fewer shares, each at a higher price, and some months you may buy more shares, each at a lower price. If the market is lower this month, you may lose money on the shares you bought last month, but this month you receive more shares, which, in the future, will help offset any losses. With Rupee-Cost Averaging, you are able to take advantage of any low during these five months, guaranteeing you to invest at the very bottom because when it comes, you are simply doing what you do every month. Once the market turns around, which it is likely to do in the long term, you'll be ahead. The best part is you didn't have to do any predicting! If you were to try to forecast the bottom, you could miss it altogether and risk putting your entire Rs.10,000 in at a bad time. Timing: Is it an important aspect Many investors ask, "Isn't it more profitable to buy as much as you can when the market is at its lowest and sell everything when it is at its highest?" Of course it is, but any professional investor will tell you that you pretty much need supernatural powers to get a correct prediction. No one knows when the bottoms and tops will happen exactly, and no one can stop surprises from happening.(In the past few weeks, analysts haven’t been able to call the right bottom, the market has corrected by over 19% ). This is why so many financial managers preach rupee-cost averaging as an optimal strategy regardless of what the market is doing: Rupee-cost averaging smoothes out the bumps of the market over the long term. Conclusion It has been very aptly put by Warren Buffet, “The Stock markets aren’t like weather that they can be predicted by a weatherman” Therefore, investors should look at Rupee-Cost Averaging as a potent tool to average losses and stay in profits for the long term.
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