02 November 2022

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The perception of the market: accumulation plan

Luigi Campopiano

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It is easy to have a distorted view of financial markets, which can be demonstrated by the perception of a form of fragmented savings known as the CAP, or capital accumulation plan.

The CAP can be compared to a piggy bank which, when we open it, will hold more money than we put in since there will also be capital appreciation through coupons or interest. This investment is based on purchasing mutual fund shares or electronic funds transfers (EFTs) through periodic payments.

Instead of investing everything immediately, it is done gradually, regularly, and for a period of duration of the plan that can be predetermined. You buy several financial instruments that will be different with each payment. If the shares of the accumulation plan cost more than the previous month because the price of the CAP is appreciating, with the same money, we always buy fewer shares than usual, but we will have a greater appreciation of the capital already invested. The reverse is true if the fund is going through a downturn, with the CAP that will appreciate or depreciate depending on the market.

We choose to invest in a CAP because we would like to take advantage of the benefits of compounded interest. We want to benefit from a much greater sum at the end of the investment with a small outlay without taking on certain risks. We decide to invest $500 per month for seven years in a bull market hypothesis: prices rise by 3.82% per year, 30% in total.

The outcome is the same for everyone at the end of the seven years.

The CAP has appreciated by 30%, but how we got to that point changes depending upon the path: the blue path has often outperformed the other two, the green one has had a linear and constant path, while the yellow one had some downturns.

Which of these three trends is best for our CAP? The most logical and immediate answer is either green or blue — they always remain in a positive zone — while the yellow one faces phases of decreases in the market. Who wants to go through a downturn on the market? Many people are afraid of that scenario.

However, if you compare the performances of the three different trends, the yellow one performs best of all, because during the downturns of the CAP, the shares that you bought every month with $500 cost less. Therefore, it feels as though you bought more.

This very common mistake is called "cognitive bias" in behavioral finance. Cognitive biases are constructs based on erroneous or deformed perceptions, prejudices and ideologies. They are often used to make decisions quickly and effortlessly.

To avoid this easy mistake, you must increase the level of your financial education. Finance is important because it represents one of the tools to help you live in the present and the future with less anxiety and fear. And the sooner you start dealing with it, the better.