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Autoinvestment or Dollar cost averaging is currently a option which is being actively marketed but there are many who have asked me when should it be used and how to use it. This article helps to throw some light on this.
[你懂的] What is it?
A regular savings plan strategy, also known as dollar cost averaging (DCA), involves investing a fixed amount of money at regular intervals over a long period of time, regardless of the market conditions or the price of the investment. This could be on a weekly, monthly, quarterly, or even annual basis.
The primary benefit of this strategy is that it reduces the impact of volatility on large purchases of financial assets such as equities. By consistently investing, you purchase more units when prices are low and fewer units when prices are high. Over time, this may result in a lower average cost per share compared to making a lump sum investment, particularly in volatile markets.
How it is supposed to work
Fixed Amount: Determine a fixed amount that you're comfortable investing on a regular basis. It's crucial that this is an amount you're willing and able to commit consistently, regardless of the market's ups and downs.
Regular Investments: Make regular investments using this fixed amount into your chosen asset or assets (stocks, bonds, mutual funds, ETFs, etc.) This could be daily, weekly, monthly, quarterly, or even annually.
Reinvestment: Reinvest any dividends or interest received back into the investment.
Long-Term: Continue this strategy for a long period of time.
[流泪] DCA might help reduce risks associated with market timing, it doesn't guarantee profit or protect against loss. Markets can stay low (or high) for long periods of time and DCA can't change that.
Choosing the asset to invest
Volatility: DCA works best with assets that have significant price volatility, as the strategy allows you to purchase more units when prices are low and fewer when prices are high, potentially lowering your average cost over time.
Long-Term Growth Potential: Ideally, the asset should have a good long-term growth potential. This is because DCA is a long-term strategy, and over the long run, the expectation is for the asset's price to appreciate.
Liquidity: The asset should be relatively liquid, meaning you can easily buy or sell the asset without causing a significant change in its price.
Affordability: You should be able to afford regular investments in the asset. If the price of a single unit of the asset is too high, you might not be able to maintain your DCA strategy.
Ideal Case for Auto-invest
Let's say you decide to invest in an ETF that tracks the S&P 500, and you have $12,000 to invest. Instead of investing it all at once, you decide to invest $1,000 per month for 12 months.
In a volatile market, the ETF's price fluctuates over the course of the year:
Months 1-4: The price falls from $100 to $70.
Months 5-8: The price rises back to $100.
Months 9-12: The price climbs to $130.
Here's how the DCA strategy plays out:
Months 1-4: You buy more shares when the price is low (14.29, 14.93, 15.87, and 16.13 shares respectively).
Months 5-8: You buy fewer shares when the price is high (10, 10, 10, and 10 shares).
Months 9-12: Again, you buy fewer shares as the price climbs even higher (7.69, 7.69, 7.69, and 7.69 shares).
By the end of the year, you've purchased about 133.97 shares in total. If you had invested all $12,000 upfront, you would have gotten 120 shares at $100 each.
Because the market was volatile, and you continued to invest regularly, your average cost per share was lower, and you bought more shares than you would have by investing a lump sum at the start. When the market went up, you benefitted more because you owned more shares.
Not-So-Good Scenario for DCA no gain but more pain from transaction fees
Let's consider a less volatile market. Suppose you decide to invest in a low-risk bond ETF with little price fluctuation. Again, you have $12,000 to invest, and you invest $1,000 each month over a year.
The ETF price remains mostly stable around $50 throughout the year.
With DCA, each month you would buy 20 shares. At the end of 12 months, you have 240 shares.
However, if you had invested the $12,000 upfront, you would have purchased 240 shares immediately and started earning interest on the full investment from the start. Because the price didn't drop significantly at any point, you didn't benefit from buying more shares at lower prices.
Thats all for now, let me know if there are any topics you are interested on. Investment is always interesting, follow me for less fluff.
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