Averaging-out Investment Principle

Auto-Investing same amount of money on a monthly basis is touted as one of the best strategies to average the buying cost. However, I was always a bit skeptical in the above principle, especially during the times when the markets are inflated in valuation . Almost all of the articles published on internet justify the average cost by convincing the investors to continue investing via auto investments /SIP in the markets , especially during downfalls to lower the average cost of buy. However, noone talked about lowering your cost of buys by not investing during times of high and unsustainable valuations. The fund managers in the mutual fund industry won’t suggest any approach that would affect the monthly inflow of cash since their livelihoods/bonus depends on it . Secondly, during bull periods, the fund managers don’t face the challenge of people pulling out, they only face that during bear periods and hence all justification is directed towards those times.

I never got the answer as to why should we continue to put money in the market, even when we have a feeling that it is inflated. Auto investing in these times will only increase my average buying cost and potentially diminish returns.My skeptical nature in this approach led me to invest in the market only during the times the index was in a fair valuation range. The moment it went past that, it led me to adopt a defensive tactic by either reducing the monthly amount of equities investments, or, cutting it off completely and hold cash.

Figure 1 :Depicts the index movement (eg Sensex) over a period of time

This led me to develop a concept and investing approach, where I can take the benefits of monthly auto-investing during periods of fair valuations, while also have the ability to pull out from the same when I am not comfortable in the prevailing market valuations. There must be a different approach to investing in different times. The above three tier approach depicted in Figure 1 is a sample example of this approach

Herein, for illustration, the moderate valuation range is kept between 23000-30000 . There are multiple historical standards you can use to arrive at such range eg Indices P/E . Lets say, at any given point of time, if the market levels are significantly lower than the benchmark , you display aggression . An aggressive stance means that you actively deploy additional capital into the equities which you have gathered via other investment vehicles ( fixed deposits, cash, bonds etc) . On the other hand, if it is in a moderate/fairly valued stage (indices are in this territory for majority of the times) , you must take benefits of monthly auto-investing via ETFs/MFs . Finally, if it goes in an overvalued territory, you must take defensive stance and hold guard, start lowering down your monthly invested amount into the market and gather cash to avoid losses and be ready to take benefits when the indices return into the undervalued territory.

The beauty of the equity markets is that the above cycle has happened in all countries for more than a century and is highly likely to continue to happen in future. Noone , however, can predict when market will enter into the three territories. The only thing you can do is to prepare your plan of action into all of the three situations.

In all practicality, it takes a lot of psychological nerve to implement it . Fear of missing out and fear of losing out during different times overtakes one’s rationality (As i talked out in my previous writing)

Over a period of time , the cash starts piling up and along with it , the challenge (which is huge in 21st century) to be patient and enjoy inaction. So , to continue to be an active participant and player into the equity markets, I ventured into the Value Investing and started finding stocks in this bull market which are undervalued and could be worthy of deploying the piling cash. It was certainly going to be an uphill task to be able to do so in a rising market.

Even though, I couldn’t find many great opportunities to compound the money, I loved this period of inaction and ventured into learning about various businesses , industries and companies and putting them into my watchlist if the price falls into my targeted range. The period of inaction must be actively utilised to be ready for aggressive times.

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