Dollar cost averaging (or DCA) is a simple technique that allows you to invest large sums of money over a period of time.
For example, if you have $12,000, you don’t invest the lump sum right away but split if over let’s say 12 months.
This way, when prices are low, investors will automatically purchase more with $1,000 and when prices are high, he will purchase less. The goal is not to time the market to get the cheapest price, but to obtain the average price.
Dollar cost averaging is primarily used by long term investors who do not wish to time the market.
Regular Savings Plan
DCA is normally used in conjunction with regular savings plan offered by several banks and brokerages in Singapore.
These services automate the entire process for you. They have differing charges and also different restrictions on what you can and cannot buy.
Seedly has a pretty good article summing up the different services on the market.
Which Regular Savings Plan Is The Cheapest? POSB vs OCBC vs POEMS vs Maybank Kim Eng
Why Regular Savings Plan May Make Sense
Other then allowing investors to start investing with smaller sums of money, regular savings plans have an added advantage of automating the entire process.
Let me explain.
Dollar cost averaging in great – in theory. Unfortunately, having to go out to the market monthly or quarterly to execute a trade mechanically over years or even decades is much more tiring than it sounds.
My own personal observation is that at some point of time, many people eventually start to get “itchy hands” and start to play around and time the market.
It is very very hard to keep doing the same thing for years and years without fail.
Regular savings plan help take that “emotional element” out of the picture.
Dollar cost averaging is great for index funds
Dollar coast averaging via a regular savings plan makes sense for me if you’re looking into investing in let’s say the Straits Times Index Fund (STI ETF).
However, using a similar strategy for single stocks is a bad idea.
While dollar cost averaging into an index fund or ETF that replicates an index maybe a passive strategy, investors might not be aware that the index itself is rebalanced or changed over time.
For example, the Straits Times Index is suppose to reflect the top 30 eligible companies. Companies are kicked out all the time. For example, earlier this year, Starhub was kicked out and replaced by Dairy Farm.
Avoid Regular Savings Plans for Single Stocks
Investing into a single stock is a very active decision that requires monitoring and understanding the fundamental changes in the business.
Although GDP should trend up over the long run, individual companies rise and fall all the time.
In the last few years, we have seen several “blue-chips” like SPH, Starhub, M1 and so on face dramatic declines.
Taking a passive role and simply continuing to dollar cost average in light of fundamental changes in the industry may not be the wise especially if there are real structural declines within the business.
Being “blue-chip” is no defense to prices dropping.
Few of the original components of the Dow Jones Index are still around, and General Electric, a company which had resided in the index for a hundred years was recently booted out.
Dollar cost averaging is a great strategy when investing in index funds. However, investors should use it with great caution or avoid it altogether when buying single stocks.