In recent years, the term dollar-cost averaging (DCA) has become increasingly popular among many retail investors in Singapore.
The idea behind dollar-cost averaging is simple. Instead of investing a large sum of money at one go, such an investor would invest a smaller, fixed amount at regular intervals over a medium to long time horizon.
Advantages of dollar-cost averaging
By leveraging on dollar-cost averaging to enter the financial market, investors are able to enjoy a few distinct advantages.
#1 Not having to time the market
As defined by Investopedia, market timing is the act of moving in (buying) and out (selling) of the market based on predictive methods.
However, as most seasoned investors would testify, predicting future prices of assets is extremely difficult, if not impossible.
One way to avoid having to time the market is to use dollar-cost averaging. When investors embark on dollar-cost averaging, they automatically buy more assets when prices are lower, and fewer assets when prices are higher. This allows them to pay an average price for their assets in the long run, as opposed to taking the risk of buying when prices are at a high.
#2 Allowing you to start investing with a small sum
By investing a small, fixed amount each month, dollar-cost averaging allows investors to start their investing journey without requiring substantial savings. With a small amount, as little as $200 a month, individuals can start building their long-term investment portfolio via the Navigator’s regular savings plan.
#3 Starting your investment journey at your own pace
Your investment journey is a marathon and not a sprint.
Some investors make the mistake of putting in too much money, too quickly, when they first get interested in investing, despite having limited knowledge about investing.
By starting out at a slower pace, getting your feet wet without taking excessive risk, you can begin earlier with a smaller savings stash and build up your knowledge.
As your knowledge and confidence grow over time, you can invest larger amounts or start making certain predictions about where you think the market is headed in the future.
How dollar-cost averaging can help you build your wealth
When it comes to wealth building, the importance of time and the effect of compounding your returns cannot be overstated. By giving your investments a long enough time to generate returns, a small periodic investment can add up a large sum of money.
By investing just $500 a month at a return of 5% per annum (compounded annually), an investor would have about $77,000 at the end of 10 years. Increase this timeframe to 30 years and the investor will have more than $400,000.
30 years may seem like a long time but it’s achievable as long as you start investing early on in your career.
Dollar-cost averaging does not mean taking no risk
One misconception about dollar-cost averaging is that it’s less risky. While there is some truth to this statement, embarking on it is far from taking a risk-free investment.
Regardless of whether you choose to invest through dollar-cost averaging or put your money into the market in one lump sum, a large part of your investment risk ultimately lies with the investments that you make. A portfolio filled with high-risk, high-return growth stocks would ultimately be a risky portfolio, whether or not an investor uses lump sum or dollar-cost averaging.
In the same way, buying only one or two stocks as opposed to investing in a diversified portfolio would mean taking higher investment risks. The use of dollar-cost averaging does not reduce your risk under such circumstances.
Assets that you can consider using dollar-cost averaging
Though commonly associated with stock investments, dollar-cost averaging can be applied to many other investment instruments. They include bonds, exchange traded funds (ETFs) as well as unit trusts.
You should ensure that the investments you make are in line with your own investment objectives and risk profiles. You can do so by structuring an investment portfolio that constitutes the different asset classes.
Investment platforms such as Aviva Navigator provides a diverse array of funds spanning across different asset classes, geographical sectors and market sectors, making your investment journey easier and hassle-free.