Dollar cost averaging: The secret to hassle free investing?

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Investing has become a common method for working adults aspiring for financial freedom. Yet, many of us may be less inclined to invest due to the popular misconception that investing is for the rich and is time-consuming.

According to an OCBC survey, about one-third of Singaporeans are not well prepared for retirement. One plausible reason could be that investing is often perceived to be a daunting task that's reserved for the rich.

For those who are less familiar with the subject matter, a method called dollar-cost averaging investing could be a helpful way to overcome the barrier and make the first step towards their retirement planning.

WHAT IS DOLLAR COST AVERAGING (DCA)? 

Dollar-cost averaging (DCA) is an investment strategy where you invest a fixed amount, usually monthly, on a given stock, exchange-traded fund (ETF) or bond. By spreading out your purchases over a period of time, DCA allows you to smoothen out the risk of the investment's price fluctuations.

For example, let's assume that you decide to invest a fixed sum of $100 to purchase a company's stock every month. When the price of the share is $10, your monthly investment of $100 allows you to acquire 10 shares.

When the price of the share declines to $8, you can acquire more shares. Similarly, as the price of the share rises to $12, you acquire fewer shares.

PHOTO: ValueChampion

BENEFITS OF DOLLAR-COST AVERAGING (DCA)

This method of investing has a few benefits that's especially friendly to budding investors. In fact, since the introduction of various DCA investment products in the market, it has grown in popularity due to the wide range of benefits for people with little financial literacy. Below are some of the main benefits of DCA method investing.

1. NO NEED TO TIME THE MARKET

For many aspiring investors, the biggest hump that they need to overcome is the feeling of not knowing when to enter the market.

A lot of people seem to be preoccupied with the thought that there must be a perfect time to buy a stock, while the uncertainty of not knowing exactly how a stock price will change deters them from making the first investment move.

Using our previous example, one might rush to sell the stock when its price rises to $12, which could forgo the potential to earn even more. Likewise, if the price of stock falls drastically to $8, one might hesitate to invest thinking that the price could drop further.

Because people are generally bad at making such guesses accurately, this type of "chasing the market" behaviour often results in bad investment outcome. DCA removes this dilemma by ensuring that you do not need to guess and time the market.

By recognising that there is no perfect method to determine the point of entry into an investment, DCA makes sure that you remain invested in the equity market and growth your wealth over the long run despite short term market volatility.

2. REDUCE MARKET FLUCTUATION ANXIETIES

Large market swings can cause anxiety among novice investors. Bombarded by multiple news sources filled with often incorrect predictions about the market, novice investors can easily make emotional and irrational investment decisions.

Some might also exit the market thinking that investment is simply not their cup of tea. DCA helps to ride out the big waves in the market due to the passive investing nature of the method. This means you do not need to constantly worry about short term fluctuation in the market.

Instead, it assists you to smoothen out the investment risk over a long horizon and build your retirement nest.

3. LOW START-UP COST

Gone are the days where investing requires a large lump sum of money. DCA is a low-cost investing strategy that does not place a significant burden on your monthly budget. You can begin investing with a monthly budget that's comfortable for you.

This is especially suitable for young working adults who have just started their career and have little savings after repaying their student loans and other compulsory daily expenses.

POTENTIAL DOWNSIDES OF DOLLAR-COST AVERAGING

While DCA provides a convenient and time-saving method of investing, there are some issues that can limit your investment return. We recommend that you balance these factors against the benefit in order to decide if this type of investing fits your needs.

1. RETURNS MAY NOT BE MAXIMISED

DCA investment may limit your returns because of its fixed sum purchasing mechanism. When the market is declining, active investors tend to preserve their capital in bull markets so that they can purchase more stocks at low prices.

In contrast, DCA commits you to continue investing a fixed sum whether or not the stock price is at more attractive levels. Because DCA commits you to purchasing stock consistently over time regardless of market movements, it reduces the potential of more significant gains, especially after the market crashes and begins its recovery.

2. NO GUARANTEED STRATEGIES

By investing in a single stock, you may face a concentration risk when the stock's fundamentals worsen.

Assuming that Company A stock price has an initial value of $5 and falls to $2 because the company has fundamentally become weaker, the stock may continue to trend downwards and perhaps sideways for a prolonged period of time.

Passive investing through DCA means that you may continue to acquire shares despite weakening fundamentals, at times, which can put your returns at risk. One way to mitigate this risk is to consider purchasing an Exchange Traded Fund (ETF) unit trust where it encompasses a pool of quality stocks instead of focusing on a single stock.

This reduces the impact of a single company stock performance on your overall investment return. Additionally, it is crucial to conduct due diligence on the fundamentals of the companies that you are investing in. Alternatively, you might consider with a robo advisor.

These platforms leverage their quantitative models to offer financial advising and wealth management services at Best Robo Advisors in Singapore of traditional advisors.

MULTIPLE PLATFORMS TO CHOOSE FROM

While you can use DCA on your own through any online brokerage, you can also find many versions of investing products that make use of DCA strategy. For example, the DBS Invest-Saver allows for regular investing at $100 per month on various ETF products, such as those that track the Straits Times Index (STI).

Alternatively, for regular share purchase on blue-chip stocks, you may consider OCBC Blue Chip Investment Plan (BCIP) or Philip Capital Share Builders Plan.

They are quite convenient because you only need to set up an account with the respective financial providers and make a monthly GIRO arrangement to transfer the fixed investment sum to your investing plan.

INVESTING NEED NOT BE AN IMPOSSIBLE MISSION 

Investing does not need to be an uphill task for beginners. The DCA method can help novice investors get their wet their feet and reducing the importance of buying and selling at the right time. Even if you don't choose to invest using DCA, it is important to educate yourself about investing as a means for saving for your retirement.

This article was first published in ValueChampion. All content is displayed for general information purposes only and does not constitute professional financial advice.