(This is part of Take Charge of Your Money , a partnership between INQUIRER.net and Citibank to help readers handle their personal finances well.)
Question: I’ve always been fascinated with the stock market but haven’t really gone into it. I recently bumped into a high school classmate and he told me that he’s now a stockbroker. Although stocks have been down because of the global financial crisis, he told me that stocks are still a good investment for the long run. Is this true? What if I just buy when stocks are low and sell when they are high? – Lito
Answer: Buying low and selling high is one of the great ways to make money in the stock market. That means you buy stocks when their prices are low, and sell them at a profit after some time.
While this seems like a good strategy, it really isn’t. According to the book The Citibank Guide to Building Personal Wealth, “In the most developed markets, market timing, which means moving in and out of equities to catch the price rises and avoid the falls, is believed to be a poor strategy for retail investors.”
Timing the market is not only unwise, it can also cause anxiety and heart attacks as you need to keep abreast of market movements daily. Besides, no one can accurately predict if stock prices will go up or down and by how much at this time tomorrow. Stocks or equities are highly volatile. It is impossible to time the market perfectly.
Your friend is right in saying that stocks are still a good investment for the long term. Experts have long said so. Checking again with The Citibank Guide to Building Personal Wealth book, “Very long-term performance figures tell us that, as an asset class, equities have produced significantly better returns than cash or bonds. For this reason, people who want their wealth to grow substantially (and are prepared to tolerate large positive and negative price movements) generally allocate part of their assets to holding equities for the long term.”
The key words are “long term.” Holding some stock investments as part of your investment portfolio will enable you to participate in gains when the market recovers from a low point. You would also be able to take advantage of bargain prices when the market takes a dive.
And to maximize your opportunities, you need to consider peso (or dollar)/cost averaging.
“Dollar/peso cost averaging means making many regular purchases of an investment over a long period of time instead of making a once-only lump sum purchase,” explain the authors of The Citibank Guide to Building Personal Wealth. “This reduces the risk that you buy when the market price is high.”
By practicing this method, you don’t need to worry about whether you are investing at the wrong time. This is because by making smaller regular purchases at different prices, in the long run, your average purchase price will generally be lower than the average price of the investment during the period.
To illustrate, suppose you invest a set amount every year for 10 years in a unit investment trust fund (UITF) dealing in equities. Because UITFs are pooled funds, you get “units” or part of the fund every time you invest. (Mutual funds run by financial institutions operate the same way.) And because equities are volatile, their prices go up and down every day, resulting in different prices per unit every time you invest. After 10 years, if you compute for the average purchase price, you may likely find out that this is lower than the actual average price during the period. This will result in a profit should you decide to sell, even if the price at the end of the period is the same as when you started.
If you have put the same amount of money regularly over the same period in a bank, it is likely that you would earn less than if you invested in an equity UITF as explained above. Bank deposits, though generally safe, yield smaller interest income.
This should not be taken to mean, though, that you should put all your investible funds in equities. Don’t put all your eggs in one basket; diversification is the name of the game in investing. Have some of your money in bank deposits, some in bonds (whether directly or through mutual funds or UITFs), some in equities (whether directly or also through mutual funds or UITFs), and more. By following this strategy, you will be spreading the risk and would more often than not stand to gain than if you put all your money in one kind of asset. You would also be able to take part in gains that could be earned in the markets.
Now you might ask how much should you put in each asset class? Talk to an investment specialist to find out your choices on where to put some of your assets given your financial goals and time horizon. Citibank clients can avail of its wealth management services. Non-clients are also welcome to schedule financial check-ups at no cost.
And after you have invested, stay invested for the long term.
(INQUIRER.net and Citibank invite readers to ask questions regarding financial matters. Send your questions to personal_finance@inquirer.net or comment through our personal finance blog called MoneySmarts )
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