Potentially grow your wealth over time with dollar cost averaging
Potentially grow your wealth over time with dollar cost averaging
Investing always carries some level of risk, so it's important to carefully evaluate your options, financial situation and goals before making investment decisions. Despite this, there is no guarantee that every dollar you invest will generate the return you desire as investment markets can be fickle. Events like war, central bank policy decisions or even election outcomes can affect market movements, and stock prices in turn.
While you may have no control over market movements, you do have some leeway as an investor to manage the impact of market volatility on your investment. One way to do so is to spread out your investment over time by investing a fixed amount of money regularly into a particular investment at regular intervals, regardless of the investment's price. This approach is also known as dollar cost averaging or DCA.
1. What is the premise behind dollar cost averaging (DCA) investment strategy?
This investment strategy is about being disciplined and being invested for the longer term.
When consistently investing a fixed amount each month, irrespective of the investment's price, you acquire more units when the price falls. Conversely, when the share price rises, you purchase fewer shares.
For instance, if you invest $1,000 per month for 12 months, the average price of the share over the period could be $10. But when you average out your cost of investing in each share, it might be $9, since you would have acquired more shares when the share price was lower.
Compared to investing a lump sum of $12,000 at the beginning, if the share price was $10, your cost of investing in this share would remain at $10.
Essentially, the premise is that by investing consistently over time, your average cost per share could be lower than the average price over that period.
2. How does DCA mitigate risk?
Let’s say instead of investing $12,000 over 12 months, you choose to place a lump sum investment of $12,000 into a stock all at once. But what if you entered the investment at an unfavourable time? This lump sum investment may potentially lead to a relatively bigger loss as the purchase price was not averaged out over time.
Alternatively, you can eliminate a single market entry risk by gradually buying over a longer period at a consistent frequency.
DCA compared to lump sum investment strategy
Source: OCBC Wealth Management
DCA eliminates the need to predict market movements so that you can spread the entry points while adding positions to compound returns over the longer term.
3. Is DCA strategy foolproof?
While DCA can help mitigate risk and potentially enhance returns over the long term, it is not a guaranteed buffer against investment losses. Diversification, research and seeking professional advice can also help enhance the effectiveness of any investment strategy.
As an investor, it is your responsibility to identify sound investments and do your research. DCA strategy assumes that the investment is made into a fundamentally sound asset that has the potential to grow over time. However, if the asset you identify happens to be a bad pick, you will only be investing steadily into a losing investment.
If you entered the market during a downturn, and the market remains depressed for an extended period, the overall return on your investment may also be lower than expected.
While dollar cost averaging removes the need to time the market, it does not guarantee that you will always buy at the absolute lowest prices or sell at the highest. If you consistently invest during periods of market highs or sell during market lows, the strategy may not yield optimal results.
Depending on the investment vehicle and brokerage fees, the costs associated with frequent investing can erode potential returns. Also, if the transaction costs outweigh the benefits of DCA strategy, then it may not be an efficient strategy to apply for such an investment.
4. Is DCA strategy for you?
While DCA as an investment strategy may not be foolproof, it can be the means for you if you are looking to build wealth over time. Dollar cost averaging is ideal for long-term investors as it helps lower the average cost per share over time. Reinvesting returns will also allow you to benefit from the power of compounding.
DCA is suitable if you are new to investing too as it takes the guesswork and emotions out of the markets. This strategy allows you to decide how much, or how little, you want to set aside to invest each month.
Investing small amounts regularly over an extended period helps to mitigate the impact of short-term market volatility, which new investors may find unnerving. You can also set up automatic transfers from your bank account to make investing more convenient and disciplined.
5. Can DCA help parents build wealth over time?
Savings alone are often insufficient to help parents save for the future. While saving money is important, it may not generate enough growth to keep up with inflation or provide substantial returns. Experiencing market dips when being invested can be intimidating, but completely ignoring the markets can mean missing opportunities for future financial growth.
With DCA, you potentially grow your wealth as you are making regular investments over time, regardless of which direction the market is going.
Let's say you invest $1,000 per month in a particular stock. In Month 1, the stock price is $10 per share, so you buy 100 shares. In Month 2, the stock price drops to $8 per share, allowing you to purchase 125 shares. In Month 3, the price further decreases to $6 per share, enabling you to buy 166.67 shares. By consistently investing, you accumulate more shares when prices are low, potentially increasing your overall return when the market rebounds.
Furthermore, you can benefit from the power of compounding by reinvesting any returns generated from your investment. Over time, compounding can help to enhance your wealth accumulation.
6. Can I use Blue-Chip Investment Plan (BCIP) to accumulate for my children’s education?
Yes, you can. You can open a joint BCIP account with your child from as young as 1 month old. You can begin accumulating blue chip stocks in a disciplined manner every month and let them compound over time to achieve potentially higher returns over the long term.
The chart below compares 2 scenarios of investing in the Straits Time Index: One with regular DCA of $100 for 18 years, and another with a lump sum investment of $10,800 after 9 years, then DCA of $100 per month for 9 years.
Source: Bloomberg, OCBC Wealth Management
As shown above, not only is DCA more affordable (no need for a lump sum of $10,800 upfront), investing consistently resulted in a higher portfolio value ($23,929.44 vs $21,742.10) and lower average price ($2,972.16 vs $3,271.17).
Furthermore, most Singapore blue chip stocks pay regular dividends; this allows you to build a stream of passive income that grows as you accumulate more stocks, up until your child goes to university. With no lock-in period, you can withdraw your investments according to your needs.
The passive dividend income can then be used to pay for their tuition fees and living expenses, lessening the financial burden on the parent later. After graduation, you can transfer the holdings to your child to give them a head start in passive income.
7. What other means are there for me to build passive income via investments?
Most Singapore blue chip stocks pay regular dividends; this allows you to build up a stream of passive income over time.
Via Blue-Chip Investment Plan (BCIP), you can invest in the shares of blue-chip companies listed on the Singapore exchange from as low as S$100 (below the standard lot size). By dollar cost averaging into BCIP, you not only adhere to the discipline of regularly investing in an asset, you also grow your passive income stream over time.
In the example below, we have illustrated how by regularly investing $100 per month for 18 years, you would have received $1,658.89 in passive income in 2023.
Source: Bloomberg, OCBC Wealth Management
You can use the dividends and reinvest into another share counter through BCIP, or you can also consider starting a Monthly Investment Plan for a unit trust or a RoboInvest portfolio.
8. How can I use unit trusts to potentially grow my wealth?
When you invest in a unit trust, your money is pooled together with other investors to form a fund. A fund manager then invests this fund into various assets to meet the unit trust's objectives. By purchasing a fund, you access a diversified portfolio at a fraction of the cost, without having to invest huge amounts of money in individual stocks, bonds or other assets.
Selected funds also give you the option to invest monthly from as little as S$100 a month. Investing monthly potentially lowers the risk of investing a large amount at an unfavourable time. You also benefit from dollar cost averaging which potentially lowers your average cost of investment over time.
9. How can I use DCA in RoboInvest to make passive income?
RoboInvest is a digital investment platform based on tested and proven algorithm technology. It is designed to help you make intelligent investment decisions without the hassle of monitoring your portfolio.
The minimum amount for monthly investments starts from as low as US$100. This low upfront investment makes it easy to dollar cost average and potentially grow your wealth over time. You can also select from a wide range of portfolios across 7 markets to cater to your investment preferences and risk appetite.
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