Dollar Cost Averaging Approach
An inquiry came in to me regarding a financial product that regularly invests into selected local shares at predetermined regular intervals. It prompted this write up.
“Dollar cost averaging (DCA) is an investment technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. The investor purchases more shares when prices are low and fewer shares when prices are high.” ~ Extract from Investopedia.
A few pointers came to mind worth elaborating as this approach to investments is oft touted locally by insurance agents via regular premium ILPs (investment linked plan). I take this opportunity as well to state my belief in that every financial product out there has its purpose, whether suitable or not for a particular client’s needs and intents, is another question to be answered another day.
DCA shifts the burden of entry market timing to exit market timing. Yes, to make money involves both an entry and an exit. Therefore, if your exit point is LOWER than the average price collected over a period of time, you actually lose money. DCA is not fool-proof. DCA is a valid investment strategy and approach.
Exit price @ 10 years = $1.10
Average price over 10 years = $1
Rate of return over 10 years = 0.957%pa
Therefore under this base case scenario, the difference between the exit and average price is a key important driver to maximise this approach. Generally, greater price volatility WITHOUT going concerns (i.e. security goes bust) should deliver lower average prices over time.
Note that if the price path over time is that of downhill and flattening with no upside (i.e. L-shaped) then DCA will not deliver returns. Remember that DCA shifts the burden of entry timing to exit timing.
Please note that costs have not been factored in, as such, returns will be adjusted downwards if so. As with all investments, nothing is guaranteed. Risk is always guaranteed though.