Dollar-Cost Averaging: Does It Really Work?
We all know the benefits of investing consistently and building a portfolio for the future. But there are countless strategies you could use, so how do you figure out one that works for you?
There are many factors that come into play such as your goals, risk tolerance, investment horizon, financial situation, knowledge, and experience. But if you’re just starting out, chances are that DCA or Dollar Cost Averaging is your best bet.
What is Dollar Cost Averaging?
According to our friends at Motley, DCA is a strategy where investors buy into a stock, in equal amounts, at regular intervals. It's like the heartbeat of your financial strategy, keeping things balanced and steady. This method can be applied to various assets including stocks and ETFs.
But there’s more to DCA than just that, here’s why it’s great:
- Reduces Impact of Market Volatility: By spreading purchases over time, DCA reduces the risk of investing a large amount when prices are high, potentially lowering the average cost of your shares. Your fixed investment buys more shares when prices are low, and fewer when prices are high.
- Cultivates Regular Investing: Reinforces the practice of investing regularly to build wealth over time. By setting aside money consistently for investing, you potentially save money you might have spent elsewhere.
- Easy and Accessible: Since you invest smaller amounts more frequently, there’s a lower barrier to entry for those who don’t have a lot of cash to begin with.
- Eliminates Emotional Investing: With DCA, you cannot be swayed by short-term market fluctuations and media hype. The temptation to react to market swings and invest poorly is eliminated.
In theory, DCA is simple.
But in practice, it requires discipline to stick to your guts even during market downturns and even if you are consistent, there are arguments against it:
- Opportunity Cost During Bull-Runs: When markets are hot for a prolonged period, the opportunity to invest a lump sum early will allow you to amass more at a lower price, and ultimately yield higher returns.
- Fees and Transaction Costs: Breaking up your investment into smaller trades will result in higher transaction fees (but that can easily be minimized at Rakuten Trade by collecting RT points and using it to pay the brokerage fees).
- Not Suitable for All Investments: DCA is typically more effective with volatile investments. For stable, low-volatility assets, the benefits of averaging out the cost may not be as significant.
Does DCA Actually Work?
DCA cushions market volatility by spreading investments over time, avoiding emotional buying at market peaks, and smoothing out average purchase prices over time.
Pairing DCA with Raku-Invest services removes market timing stress, allowing regular fixed investments regardless of market performance and helping investors stay focused on long-term goals.
To see DCA in action, let's compare it with lump sum investing using an example with Netflix stock from September 2021 to February 2024: .png)
If you went all in with RM15,000 on 1st September 2021, your portfolio value would remain largely unchanged even by 2024 February. It would actually go down a slight 0.01%.
But if you consistently contributed RM500 from the start, your portfolio would already profit by 2023 May despite the share price dropping, and you'd make over 52% by February 2024 because your average share price is lower.
Here are more reasons why Raku-Invest is great:
No More Timing the Market: You don’t need to worry about when to invest.
Wide Selection of Stocks: Choose from over 1,000 US stocks and ETFs.
Accessible and Flexible: Start from RM100 to RM9,999
Rakuten Trade Perks: Easily trade in MYR, no need to convert your cash into USD. Earn RT points as you would from regular trading and use them to offset brokerage fees for future trades.
So, when it comes to investing, keep it cool, keep it consistent, and keep dollar cost averaging in your arsenal. Not only does it spread the risk, but it kicks the drama out of investing too!
