Hi, I’m Cindy Ng. I have RM 12,000 to invest in the stock market. My question is: ‘Should I invest the sum in full or use the Dollar Cost Averaging (DCA) method to spread out my investments to around RM 1,000 per month or RM 3,000 per quarter?
For a start, let me explain what Dollar Cost Averaging (DCA) is and how it would impact investment returns. DCA is a popular investment strategy that is used by retail investors to invest in liquidable assets for the long term. They include unit trust, stocks, bonds, pension funds, gold, silver, ETFs, debt crowdfunding … etc.
To illustrate, let’s say, Cindy is interested in investing in a stock, DV Bhd. She has two options. Firstly, Cindy may invest RM 12,000 into DV Bhd. Secondly, she can choose to invest RM 1,000 a month or RM 3,000 per quarter for the next 12 months. The question is: ‘Will there be a difference in Cindy’s investment results?’
The answer is Yes.
Scenario 1: Rising Stock Price
If stock price of DV Bhd continues to rise, Cindy would be better off if she chose to invest her RM 12,000 in full into the stock instead of the DCA method. This is because Cindy would have more shares of DV Bhd and attain higher capital gain from her investment.
Scenario 2: Falling Stock Price
However, if stock price of DV Bhd keeps on falling, Cindy will incur lower capital loss if she chose the DCA method for she would end up with more shares of DV Bhd as compared to her investing RM 12,000 in full.
The Effectiveness of Dollar Cost Averaging (DCA)
In essence, DCA lowers investment profits as it encourages investors to keep on investing into a stock despite a rise in its stock price. It also reduces losses from the investment as it encourages investors to invest when its stock price declines over time. This is because DCA is intended to help investors invest over the long term and not be short sighted with the ups and downs in the stock market.
In practise, most people would find the DCA method of investing hard to follow as we are emotional beings. We may invest more when times are good because we are optimistic. We may invest less or shun investment at all cost when times are bad as we become pessimistic. Often, it is fear and greed that would trigger one’s investment decisions than logic itself and hence, causing huge volatility in the stock market worldwide.
Do I Use Dollar Cost Averaging (DCA) when Investing?
Personally, I am a value investor and believe that a stock investment is good if it is fundamentally solid and reasonably cheap.
DCA is workable only if the investment vehicle is fundamentally solid. If you use the DCA method to buy mediocre stocks, your investment returns would still be mediocre in the long-term. It is not a protection against a bad investment move from an investor. Thus, I find it important to first assess the business model, the management team and financial strength of a stock first before investing as this assessment helps me to reduce the risk of making a bad investment.
I am in favour of DCA as it encourages investors to adopt a mindset where stock investing is viewed to be a long-term activity of accumulation of shares of great businesses regularly for the long-term.
However, I dislike the idea of buying shares of good companies at high prices as it does not make sense to overpay. This is why I use valuation ratios such as P/E Ratio, P/B Ratio and Dividend Yields to determine if the price of a stock is cheap or expensive. Thus, instead of using DCA, I improvised the investment strategy.
I call it – Value Cost Averaging (VCA) and I’ll share it in my next article.
Back to Cindy: To Invest in Full or Use DCA?
There is no straightforward answer to this question. Instead, I would offer three questions as a guide to answer to help you decide which is more suitable, if you are Cindy today. They are as follows:
Question 1: How Much is Your Monthly Savings per Month?
If Cindy is able to save about RM 1,000 a month, the RM 12,000 in initial capital to her would relatively be a large sum to her. Instead of investing the sum in full into stocks, Cindy can divide her initial capital into RM 1,000, which will then be invested together with her monthly savings of RM 1,000. In essence, she would be able to invest RM 2,000 a month, thus, allowing her to build her portfolio on a progressive basis over the next 12 months.
But, if Cindy is able to save RM 5+ thousand a month, the RM 12,000 would not be a substantial amount to her as compared to her saving RM 1,000 a month. If that is her case, she may opt to invest the RM 12,000 in full instead of using the DCA or VCA method. The decision would also be dependent on Question 2:
Question 2: Which Stock Market Would You Like to Invest Into?
The transaction fee, consisting of brokerage fee and stamp duty, when investing or divesting shares, are different based on your preferred markets. The amount of fees per transaction is about RM 12 for Bursa-listed stocks, SGD 32 for stocks listed on the SGX and USD 30 for stocks listed in the United States.
Thus, if Cindy chooses to invest RM 2,000 a month, it would be better for her to invest locally to lower her transaction cost per share. It is more cost efficient for Cindy to invest in the Singapore or the US markets if she plans to invest more of her capital, ideally at least RM 10,000 per transaction.
Question 3: How Do You Rate Your Investment Skills and Confidence?
If Cindy is a seasoned investor and is confident with her investment skills, Cindy can choose either to invest in full or use the DCA method, whichever is suitable for her situation. But, if Cindy is just beginning her journey in investing, it might be better for her to first learn about stock investing and start small. Then, if she is more confident, she can choose to invest a bigger sum in the future.
All in all, DCA is intended to promote long-term investing by fixing your amount of investment sum on a periodic basis. As such, it is a good way for anyone with a monthly income and limited capital to start investing. With that being said, its investment strategy is not intended to be a complete parachute for a mistake in your investment. Hence, it is still important for investors to evaluate the quality of an investment vehicle before committing to it.
I’ll share Value Cost Averaging (VCA) in length in my next article.