Quoted from ‘thesundaytimes, June 22, 2008′ Page 26 invest [ small change ]
Last month, I shared about how I like to “pay myself first” by having money channelled automatically from my payrol and deposited straight into regular savings plans.
A closely related concept is “dollar-cost-averaging”, which could be a part of such plans, if one intends to enter the investment market at regular intervals.
Infact, many financial experts prefer dollar=cost averaging to lump-sum investments-particularly when protecting against paying too much for investments in a volatile market.
This is how dollar-cost averaging works. The same dollar amount is invested at regular intervals, say monthly, into a diversified investment portfolio. This arrangement holds regardless how the market is doing. As a result, the price paid for the shares or unit trusts is averaged out.
This means more shares are brought when prices are low and less when prices are high.
The natural question that comes to mind is how preading one’s investment over time, via dollar-cost averaging, gives you better results than investing alump sum in the market. Let’s examine which method is better.
Method 1: Lump-sum investing
Doing this effectively means timing the market by trying to buy low and sell high.
It’s great if one succeeds but in reality, most people fall on their face. Such investors lose money primarily because their greed and fear results in an inaccurate reading of the market. Studies from US-based research firm Dalbar have shown that those who attempt to anticipate market movements usually run the risk of exiting and entering the market at the wrong times.
For example, let’s assume you have $10,000 and you want to purchase stock A, whose price recently fell to $10 a piece. Having seen it hit a high of $15 a share previously, you think this is a good time to buy. and go on to purchase 1,000 shares. A month later, the shares dip to $5 a piece, but you decide to hang to them. Ten months later, stock A remains at $5. you now make a paper loss of $5,000.
Method 2: Dollar-cost Averaging
This method entails dividing the principal sum of $10,000 into equal amounts of $1,000 and investing the smaller sums every month for ten months, regardless of how the market is doing.
Let’s say that the piece of stock A remains at $10 for the first five months and falss to $5 a share in the next five months. Using dollar-cost averaging, you would buy 100 shares with $1,000 in each of the first five months and 200 shares with $1,000 in each of the next five months.
As a result, you are able to buy more shares when the price is low and this means owning more shares overall.
At the end of 10 months, instead of having 1,000 shares, as would have been the case if you had invested a lump sum, you now have 1,500 shares. And even thou the share price is down to $5 a piece, your holdings are worth $7,500, instead of $5,000 you would have lost if you had done a lump-sum investment.
With dollar-cost averaging, you are able to limit your loss when the market is trending down. This method also eliminates the risk of market timing and creates the discipline to stay invested in the market at all times.
These reasons explainwhy investor are better off using dollar-cost averaging in the long rubn.
[...] sum. For those who like dollar cost averaging, ETFs are not the best choice. They are more conducive to lump sum investing. Plus, with the dollar [...]
DCA is a disciplined investing methodology that works well for the average person who does not want to: watch their investments weekly, time the market, be bohtered with decisions, decisions, decisions!