Busting 4 myths on dollar-cost averaging
Coke or Pepsi? Dogs or cats? Koi or Gong Cha?
These are some of life’s perennial questions that will have their equal share of supporters on both sides. Add one more to the mix: Dollar-cost averaging (DCA) or lump-sum investing?
This is a question that, like the most important questions in life, has left retail investors divided. But first, what exactly is DCA?
What is dollar-cost averaging (DCA)?
It’s a simple idea really: Investing in fixed intervals at fixed amounts - no matter what the market condition looks like. This means you automatically buy more units when prices are low and fewer units when prices are high.
DCA also sometimes goes by a different name: Regular savings plan (RSP). But it is essentially the same thing, because you set aside some money to invest on a regular basis. For example, DBS/POSB Invest-Saver allows you to invest with as little as S$100 a month.
Another typical method of investing is lump-sum investing. This is when you invest with a chunk of money rather than slowly trickling it in. Some investors like this method because it goes with the maxim: Buy low, sell high.
There are pros and cons to each investing style, but while lump sum investing is more commonly understood, there are some misconceptions about DCA. We pick out a few myths about DCA that ought to be busted.
Myth 1: DCA is expensive and costly
Fees are usually involved when it comes to investing, whether it’s a platform or brokerage fee, or commissions for fund managers. A high fee is disadvantageous as it eats into your returns. For example, if your costs are 5% of the amount invested and your returns reap a 6% increase, that’s just a 1% gain for your investment.
Many think that DCA means incurring repeated fees as you frequently dip your fingers into the market. This may be true if it is a fixed cost, say S$10 for every trade made. This adds up, especially if you are just investing S$100 each time.
But if the cost is a percentage of the amount invested, then it costs the same as lump-sum investing. For example, DBS/POSB Invest-Saver has a sales charge of only 0.82%, which means you pay only S$8.20 whether you invest S$100 every month for a period of 10 months, or S$1,000 at one go. Look out for deals too. From 1 February to 30 April 2021, you can get a full rebate of up to S$125 on sales charges for your DBS/POSB Invest-Saver transactions.
Always compare across platforms to get the best deal in terms of fees, but take note that different regular savings plans give you access to different markets and investment funds. If you do find a product with a reasonable fee, it might be a good option to go for it.
Ultimately, it could be more costly to hold on to cash, as inflation of about 3% per annum will erode the value of your savings. Inflation is the opportunity cost of not being invested in the market.
Myth 2: DCA doesn’t allow you to “Buy Low, Sell High”
For many who are new to investing, the first thing you learnt is likely to be: “Go in low, exit high”. This is called timing the market, where you speculate when is the most opportune time to buy or sell. Once you sense the right time to go in, you dump in your money and hope for the best.
The best-case scenario is if you invest at the bottom of the market and exit at the top of the market. But it is not that simple. It is notoriously difficult to know when to do this. Behavioural studies have shown that there is a strong instinct to follow the crowd, which explains why investors buy in bull markets at the peak, and sell in bear markets at rock-bottom. A mix of the fear of missing out as well as holding out and thinking prices will rise contribute to these actions.
But you can avoid these make-or-break decisions by incrementally investing in the market through DCA, which is known as having time in the market. It reduces the risks of extreme outcomes, whether negative or positive. Essentially, DCA helps you to stick to a plan and takes emotions out of the process. You don’t keep second-guessing your decisions and it could help you sleep better at night instead of fretting over what might be!
There is definitely a strong case for time in the market over timing the market: It’s not always about buying high and selling high.
Myth 3: DCA gets you meagre returns
The potential upside of lump-sum investing is higher than DCA. But the opposite is true as well – the downside could be extreme and you could take heavy losses. There is hardly a guarantee that going big and all-in is better. Incremental investing might just be the way, especially if you have a long investing horizon, where you are able to stay invested in the market for years or even decades.
This is a sound strategy for steady progress. Historically, the stock market has seen more ups than downs even through years of global disasters, economic crises and wars1. If you stay invested, there is a good chance that you will see your investments grow.
And going slow and steady in the race will likely get you substantial returns in the long term. If you invest S$100 a month with a return of 4% per annum, it will have a “snowball effect” 20 years down the road. This means a total deposit of S$24,000, invested in monthly sums of S$100 over a 20-year period, will see a 50% increase in quantum at this rate of return, to become more than S$36,000. Far from meagre.
Myth 4: DCA has lower potential for returns
The year 2020 has shaped up to be one of the most volatile years on record for markets. In March, the S&P 500 saw three consecutive sessions of more than 9% swings for the first time since 19292, which is when the Great Depression happened.
If you had invested in video-conferencing giant Zoom at the start of this year, you would have seen your portfolio jump by three times. This statistic alone has made some believe that lump-sum investing is better than DCA.
It is true that DCA may generate lower returns. A Morningstar study3 in 2019 showed that investors with DCA did better than lump-sum investors just 27.8% of the time for 10-month periods, while the figure dipped to 10% for 10-year periods. Yet, these numbers only make sense with hindsight. Studies show that many people don’t even want to get invested to begin with, so DCA is a good way to enter the market slowly and safely.
We won’t see the end of the DCA vs lump sum battle anytime soon and it will continue to rage on. But hopefully, this myth-buster piece leaves you with a clearer idea of DCA, making it a little more real and a little less mythical.
Find out about how you can grow your wealth steadily and securely with DBS/POSB Invest- Saver.
Or contact us for more information!
Tell us if you will consider using our financial planning tips
1 Stock Market History: More Ups Than Downs. Forbes. Published 20 Sept 2017 https://www.forbes.com/sites/johndobosz/2017/09/20/stock-market-history-more-ups-than-downs/?sh=433840aa3951
2 S&P 500 Posts Three 9% Swings for First Time Since 1929. Bloomberg. Published 16 March 2020. https://www.bloomberg.com/news/articles/2020-03-16/s-p-500-index-hasn-t-posted-three-9-moves-in-a-row-since-1929
3 When Dollar-Cost Averaging Can Help (or Hurt). Morningstar. Published 4 September 2020. https://www.morningstar.com/articles/1000679/when-dollar-cost-averaging-can-help-or-hurt
Disclaimers and Important Notice
This article is meant for information only and should not be relied upon as financial advice. Before making any decision to buy, sell or hold any investment or insurance product, you should seek advice from a financial adviser regarding its suitability.
All investments come with risks and you can lose money on your investment. Invest only if you understand and can monitor your investment. Diversify your investments and avoid investing a large portion of your money in a single product issuer.
Disclaimer for Investment and Life Insurance Products