Technics of Investing: Part I - Cost Average EffectsteemCreated with Sketch.

in steemleo •  8 months ago 

While it is always risky to invest in any asset there are different methods and technics to dampen the risk involved.
One famous and widely know effect - also disputed by some academics - is the cost average effect.

The cost average effect claims that diving a larger sum and investing those equal installments of a fiat money each interval will be superior to a one off investment.
So if the price of an asset goes up you buy automatically less of it and if the price of the asset goes down you buy automatically more as you invest each month (e.g) the same amount of money.
While some academics argue that in a bull market, where prices increase heavily over one year, a one time investment at the start of the year or in volatile market, where prices crash down and hence present a buying at the dips opportunity, outperform the cost average strategy, I believe they do not get the point.

First of all many of us simply do not have the possibility of a huge one time investment, hence there is no way to do it different then (monthly) installments.
Secondly - and more importantly - how do you define when the market is down, cheap, at its bottom or expensive and topish?
If you are willing to take the risk, you might try to do market timing and get all the return possible.

But in my humble view the major problem we "normal" people encounter doing investments is not to miss some gains but to loose our investment / pay a too high price for it. So usually one makes the decision to go for an asset like shares, funds or even crypto to some extend. But how do you know if it will be cheaper or more expensive next month?
So I would advise everyone to consider the cost average approach of investing...
Here is a very good summary of the academic discussion of the cost average effect:

The US already has a very dense stock and fund ownership, as does England and Canada. But many other countries, especially European countries and emerging markets have a very poor distribution of stock ownership.
So given superior long term returns of the financial markets vs. savings accounts it seems very clear that most people are put away by the possible associated investment risk - and this is of course not a good thing for those people.
While many of you probably will find that investing in the "old" financial markets is not such a good idea, I argue that the cost average effect could also work for alternative investments, especially crypto investments.
So it comes down to the same...

Of course in a bear market cost average effect will always be superior to one off investments and hence I could now claim look at crypto from the start of 2018 until now.. but this would be unfair.
Looking at time spans form the start of 2017 or 2016 of course, one time investments would have been superior as crypto prices doubled nearly every few weeks...

But as we are now living in a new and very volatile crypto world and nobody knows for sure where price will be in one month, one quarter, one year... what would you tell a friend who comes to you and asks you if he should invest a part of his hard earned savings into crypto at this very moment?

So of course first step would be to understand if he really knows about the risk he is taking by investing in cryptos at all and if he really only invest what he can afford to loose... But if all the boxes are checked and your friend does not simple invest some gambling money, monthly or quarterly installments will definitely damp the risk of your friend investing at the top of the market.

In financial mathematical terms this of course makes no sense as you would only invest in assets that you expect to increase in value over time, so an investment as early as possible will academically always be better.

But reading Kahneman's Thinking fast and slow shows that our brain and mentality suffers much more enduring a loss of say 100 USD compared to gains of 100 USD left out. So everyone that is in this unfortunate position to be asked for financial advise should keep that in mind. Your friend has mentally to feel fine with his investment - in all possible market environments - or at least in most.

This is of course by no means an investment advise! Crypto and other investments are associated with very high risk, total loss of your investment is definitely possible. This article about general investment technics/methods should only teaser you to study and read more to find the right approach for you.

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Dear @solarwarrior

I just had a pleasure to bump into your old publication and I was wondering when will you publish second part? Seriously another great read.

To leverage cost was one of my very first lessons when I decided to learn how to trade a while ago (I hate trading, but I need to understand traders and there is no better way than to do it yourself for few months to learn a little bit).

I thought that perhaps I could share with you my latest publication and ask about your own opinion on discussed subject:


I would appreciate it greately.


I think your advice is very sound.

I believe in dollar cost averaging.

That being said with all the new growth on Steem engine I don’t think the market price is reflecting the value we have here.

I could be a fool, but I just bought and powered up Steem last night.

Of course the price is now down Lol it always does after I buy🙃😊

Posted using Partiko iOS

I would be an even bigger fool as I bought already some days ago.. but same with me.. I am not a good trader.. I see value and am an an investor... usually over all asset classes my timing is short term sub optimal but long term it works out just fine.. I hope this time is no different.. ;-)

I am in the same camp as you.....

Just look at Steems price today, I usually trade on Coinbase Pro and my USD deposit takes 5-7 days to clear.

I wait for the best “buy” price, and it usually goes down after I buy Lol🙃

I am in this for the long term, if I miss a short term dip that’s OK.....

Posted using Partiko iOS

If you cannot time a market, cost averaging is the best strategy you can follow. This is also what I do.

completely agree... people who are good at market timing should measure their performance (alphas) if they really have an edge or if they just think so.. on the other hand look at all those fund manager gurus who use extensive market timing / hedging technics successful for some years in a row and then in one year just get it totally wrong..
so yes.. market timing based on economics is the champions league of investing but only because one manger got it right for 5 straight years doesn' t mean that you can't rule out its poor luck...
and from my point of view Warren Buffet and Charlie Munger for example never do market timing per se.. they always keep a pot of cash just in case a cheap buying opportunity arises...

and also on another note.. markets are not crashing and bottoming because only stupid people sell below fair value.. at the markets bottom also most professionals sell and don't buy because also the professionals are in panic.. only a very small group of investors is able to overcome the overall market fear and risk their money at this moment...

It helps if you are not all in... if you can live with the book loss, it is much easier to buy when the price is low ;-)

I think that dollar cost averaging also works well if you plan on holding an investment for a long period of time like 5, 10, 15 + years. Many markets and individula investments increase in value over the long run so the short term dips do not matter as much the longer one holds the investment. Its also extremely difficult to determine what markets will do over the shirt term. Sometimes you can wait for a dip or bear run that never comes and you might completely miss out on an opportunity or several opportunities if the asset ontinues to increase in value.

yes.. you are right..
academic bases nearly all starting points on the home economicus that makes 100% rational decissions whereas we human beings are guided by greed and fear.. hence technics to put our emotions aside and make us to ice cold investors should benefit our overall performance.. and the cost average effect is such a technic - if you keep to the plan.. keep to the plan.. keep to the plan.. ;-) even if hell freezes over..

If someone comes to me for financial advise (friend) to invest a single large sum in the financial markets I know that the home ecomnomicus would invest asap - precondition you expect a advancing market.. but just imagine you give your good friend the advice to invest the whole sum destined for risk assets in the equity market now and then something like the financial crisis happens 3 month later.. better make some invest by some installments and do not get the full reward than crashing your portfolio...

to make this picture even more precise:

Imagine someone offers you one million dollars.
or a one in a thousand chance to win one billion dollars.
The expected outcome / value is one million in each scenario, hence you should be indifferent between the two choices but actually this is not how life is and how most of us would decide.
The economic value for a single person of one billion USD is not 1000 times that of a person having one million dollars (compared to nothing)...

or why would anybody play the lottery knowing the expected return is -50% ?

Investment advise has to be for the irrational human being.. not for a robot..

I absolutely love to see how responsive you are @solarwarrior