Dollar Cost Averaging Method - Again!

The Regular Savings Plan (RSP) utilizes the dollar cost averaging (DCA) concept of investing which is the practice of investing a fixed amount of money regularly regardless of market conditions. In the case of RSP, the investments take place monthly. This article helps investor understand the benefits of DCA and what considerations that an investor has to make in executing a dollar cost averaging plan.

Benefits of Dollar Cost Averaging

For many investors, market timing of buying low and selling high is almost an impossible task especially when fear and greed typically lead investors to do the opposite of buying high and selling low. The main benefit of DCA is that it takes the guesswork and emotion out of investing. By investing a fixed amount on a monthly basis, RSP ensures that you accumulate more units when prices are low but lesser when prices of units are high. A lot of stress is avoided as the investor does not have to decide whether the fund is expensive or not and whether the market condition is suitable to invest. Table 1 shows a hypothetical example of how more units are acquired when prices are low and vice versa assuming that an investor invests $100 every month. Chart 1 is the graphical presentation.

Table 1

	Investment amount (RM)	*Price (RM)	Units Acquired
Jan	100	1.00	100.00
Feb	100	1.14	87.72
Mar	100	0.90	111.11
Apr	100	1.03	97.09
May	100	0.95	105.26
Jun	100	0.89	112.36
Jul	100	1.08	92.59
Aug	100	1.19	84.03
Sep	100	0.85	117.65
Oct	100	0.98	102.04
Nov	100	1.17	85.47
Dec	100	0.83	120.48

* Prices are randomly generated

Source: iFAST Compilations

Chart 1 : Graphical Representation of Table 1

Many investors procrastinate in investing, preferring to accumulate a large sum of money before deciding where to invest. The temptation of spending the sum meant for investments could also derail longer-term financial goals. By deducting a fixed sum of money from the bank account and placing them into funds, RSP also instills discipline in investing. This helps investors steadily move towards their financial goals. Moreover, with investors now starting young, many may not have the luxury of investing a large lump sum. RSP becomes a practical method of "invest-as-you-earn".

Lump sum investing would be better for investors with long investment horizon

DCA is a strategy that works well in a market environment that is volatile, experiencing both upswings and downswings but ends at a level that is close to the initial level. However, historical data shows that most stock markets do exhibit an uptrend over the long term. This means that for investors who have a large sum of money to start their investments with and coupled with a long term investment horizon, they would be better off investing the money right away (refer to " Long-Term Investing Works").

Although lump sum investing works better than DCA assuming that stock markets continue their long-term uptrend, investors are often paralyzed with fear in times of heightened volatility such that they put off investing. These investors can consider DCA in such times to start their investments. By breaking the lump sum into smaller parts, investors can view it as a chance to average down their costs when markets move down. On the other hand, if the markets move up subsequently, investors would have already invested part of their money. The main benefit of DCA in times of heightened volatility is that it helps investors overcome the fear of investing in turbulent markets.

Now that we have explained the benefits of DCA, the following steps would help the investor execute the method of DCA through RSP.

Actions to take for RSP

• Decide on the monthly amount that can be sustainable over the investment horizon

• Select the funds to invest into, making sure that portfolio is diversified.

• Rebalance your funds at least annually to ensure that your portfolio remains diversified

• Wait for your investments to reap rewards.

Source : http://www.fundsupermart.com.my/main/research/viewHTML.tpl?articleNo=118

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