Dollar Cost Averaging

Here is my favorite finance planner's blog. What I like to do is to go over the blog again, I specially like to dive into the dollar cost averaging table, and then look into things I should learn from.

This is best teaching compared to all other on youtube.com. I specially like to learn from data. Based on the table in the blog, I will write another blog and continue to do my case study of IRA CD account analysis.

Highlights of good teaching in the blog:

1. Market timing, how to avoid market timing
2. Falling market is the great time to invest, why? How to invest?

Falling market, gains, regular saving, how to gain from a falling market. There are a lot of good ideas out there. One of them is to save monthly and put them in the stock market. 

Dollar cost averaging

Dollar Cost Averaging is a strategy in which an investor places a fixed dollar amount (or indeed any other currency) into a given investment such as a unit trust, on a regular basis.

The investment generally takes place each and every month regardless of what is occurring in the financial markets. As a result, when the price of a given investment rises, the investor will be able to purchase fewer units. When the price declines, the investor will be able to purchase more units.

Millions of investors around the world employ a dollar cost averaging strategy because it offers the following benefits:

• It’s an attractive option for investors who want to contribute to their investment portfolios on a regular basis.
• It eliminates the issue of ‘market timing.’ As a result, an investor’s returns will be determined more by the overall trend in a given fund as opposed to the investor’s specific entry price. In addition, it helps investors reduce their cost basis on securities that decline in value.

My sharing

Why market timing is not a good idea? I like to say something. Buy high and sell low. Cut the loss when the market is low. Loss aversion is bias of investor, I did sell VIGRX fund in 2002 and then I totally forgot it. 

Example:

Two cases

It is great investment opportunity for a stock price with 30% loss in value; how to take advantage of the loss of value? One of ideas is to continue to purchase no matter the price goes down or goes up. 

You decide to invest $1000 per month into two funds. During the first 12 months, Fund A shows steady growth at 2% per month. Fund B falls by over 30% in the first few months, recovering back to the initial level by month 12. In which fund will you have accumulated your greatest investment value?

The answer might be surprising. Take a look at the figures:

Let us review the facts:

           Fund A             Fund B

gain    $1401               $3389
units   107.82              153.89

For example, if I purchase Vanguard total market index fund, as long as I continue to purchase the fund, I will be able to make more profit if the market goes down and goes up again. Recession, market correction is good for me as a long term investor.

In summary, over 12 months, Fund B has delivered better than twice the returns of Fund A in percentage terms!

A few more ideas to share in the following:

1. The Dollar Cost Averaging strategy for reducing market risk relies on (i) you having a suitable time horizon for your investments, and (ii) your chosen fund recovering from the decline and returning to the upward trend. In the example above, if you needed access to your funds when Fund B is low, you will make a loss on surrender.
2. Dollar Cost Averaging reduces market timing risks for volatile investments and is a reason why regular savings plans are so popular for building long term financial security. The example above could be twelve years rather than twelve months, but the concept and outcome holds true.
3. Dollar Cost Averaging can be appropriate when considering higher-risk investments such as emerging market funds, if the investor anticipates a positive overall trend in the medium to long term.

Actionable Items

I plan to read more posts from the author. Here is the list of posts for me to read.