Investing can be scary for beginners. There’s a seemingly endless number of things to learn and you’re always worrying about whether you’re putting your money into the right assets.
Enter Dollar-Cost Averaging. This beginner-friendly strategy makes the investing journey less intimidating by keeping the risk of “being wrong” low. It’s a strategy that even the most experienced investors still use, making it something worth looking into.
Here’s what we’ll be covering:
- What is DCA?
- Pros & cons of DCA
- Myths about DCA
- DCA vs Lump Sum Investing
- Examples of how you can incorporate DCA into your investment strategy
What is Dollar-Cost Averaging (aka DCA)?
With DCA, you choose an asset you believe has a good long-term outlook, then invest a fixed amount into it every month. This ensures that you’re consistently investing month after month.
This is effective for one main reason: statistically, time in the markets is better than timing the market.
Say for example you want to invest $15,000 in total this year. Instead of waiting for the perfect time to buy $15,000 worth of equities at one go — and possibly never finding the right time — you’ll put in $1,250 by a fixed date every month instead.
The benefit of DCA is that it neutralizes short-term volatility in the markets. Equity prices change day by day (sometimes minute by minute!) and you don’t want to find out you happened to invest your $15,000 when prices were at an all-time high. DCA ensures that you’re paying the average over time.
It’s also great for the beginner investor because it doesn’t require much effort: you can set it up so you’re transferring the same amount and buying the same ETF every month.
What are the Benefits of Dollar Cost Averaging?
Apart from smoothing out risks and being low maintenance, DCA also offers tons of other benefits for investors:
1. Removes the psychological barrier to investing
DCA requires you to invest regularly regardless of the market’s movements. You don’t need to worry about the price of the asset before making your purchase. Since even seasoned traders have trouble consistently predicting price movements, this helps new investors avoid that trap.
2. Makes investing accessible even with small capital
DCA is a relatively low-cost strategy since new investors can start investing with as little as $50. Growing your wealth with investing is no longer available only to those with lots of capital at hand.
3. Instills discipline and helps new investors build confidence
DCA requires the investor to set aside a fixed amount of money each month to continue investing. Otherwise, the strategy will be ineffective. It’s also a great way for new investors to build up a sizable portfolio from small amounts that keep accumulating.
Cons of Dollar Cost Averaging
1. Higher transaction costs
Each transaction you make with your broker will incur costs (e.g. platform fees, transaction fees, commissions). Having to invest monthly through DCA means that you’ll be performing a larger number of transactions, so you’ll need to watch out for the costs you could potentially incur.
This isn’t as much of an issue if your broker charges a percentage of each transaction. If you pay 0.8% commissions on 10 payments of $500, it’s the same as paying 0.8% on one lump sum of $5,000. Some brokers charge a flat fee for each transaction though, which can be costly for a DCA strategy with smaller monthly investments.
(Check out this article for a quick comparison of the costs of various platforms.)
2. Historically lower returns compared to lump sum investing
DCA is usually compared with lump sum investing, which we’ll discuss in a later section. History has shown that lump sum investing outperforms DCA in the long run.
In exchange though, you’re taking on greater risk. That’s why it’s important to consider your risk profile, timeframe, and amount of capital before selecting a strategy. Still, DCA is great if you don’t have a ton of capital to start out with.
3. Dollar Cost Averaging won’t save a bad investment
Despite its effectiveness, DCA still requires you to pick your assets wisely. That’s why most investors using this strategy invest in diversified vehicles that track the entire market — such as the S&P 500. Instead of betting on a single company to grow, you’re basically saying, “I think the global business environment will continue to recover and grow over the long term.”
3 Myths Associated With Dollar Cost Averaging
1. DCA goes against “Buy Low, Sell High”
The concept of “Buy Low, Sell High” is also known as timing the market. You’re trying to predict when the asset price is lowest before you buy in.
It sounds easy but is difficult to pull off in reality. That’s because many new investors are prone to following the crowd and falling prey to FOMO. DCA prevents this by helping you stick to a plan and taking your emotions out of the investing process.
2. New investors can’t apply DCA effectively without the help of a professional
It’s natural to be afraid of making mistakes as a new investor. However, since DCA doesn’t rely on individual stock picking, it removes much of that risk from the process.
3. DCA has lower potential for high returns.
Each investing strategy has its pros and cons. Despite DCA showing lower probabilities of outperforming lump sum investing in the long run, it’s a great way for new investors to build up a sizable portfolio slowly and safely.
Dollar Cost Averaging vs. Lump Sum Investing
As the name suggests, this refers to investing a large amount of money at one go into an asset. This strategy best suits those who have a considerable amount of idle cash to invest. It’s also an option for the investors who want to quickly build their portfolio into a sizable amount.
Questions to ask before deciding on DCA vs. lump sum investing:
- Are you more or less risk averse?
- How much spare cash do you have at hand currently?
- What’s your investment objective?
Here’s a simple table to help you decide:
|Dollar Cost Averaging||Lump Sum Investing|
|Suitable for more risk-averse investors||Suitable for less risk-averse investors|
|Investors with less capital available||Investors with a considerable amount of idle capital available|
|Investors who want slow and steady returns||Investors who want high growth and can take a hit to their portfolio in the short term|
|Investors who may be prone to “analysis paralysis” in deciding on the right time to enter the market||Investors who can regularly monitor the markets for corrections|
How to Incorporate DCA into Your Investment Strategy
The first step is to decide on a platform to invest with. Pay attention to:
- Account minimums required
- Commission rates, platform fees, annual management fees if any
- Available markets (check that it offers access to the region you want to invest in)
Once you’ve got your platform settled, it’s time to dive into how you can execute the DCA strategy.
1. Through Regular Savings Plans (RSPs)
You can start a RSP under your broker, which will allow you to make regular investments into asset classes such as ETFs, unit trusts, REITs, and so on.
Common recommendations for new investors in Singapore would be the Straits Times Index (STI) Fund that comprises the top 30 companies listed on the SG Exchange. You can also invest in international ETFs that provide higher growth, but watch out for the related taxes you may incur.
Read also: 5 Investment Tips for Beginners in Singapore
2. Through a Robo-advisor
Robo-advisors such as StashAway and Syfe are great for investors who prefer a less hands-on approach to investing. All you need to do is to set up automatic deposits into your portfolio through your bank. Once you fill out a quick survey to set your investor profile, they will automate the remaining processes for you.
Kickstarting your investing journey is not a complicated process, nor should it be daunting. With DCA, anyone can invest even with little experience and in any asset — even for volatile assets such as crypto. All you need to do is set aside money each month to invest on a regular basis.Lastly, regardless of which strategy you opt for, the key is to start early for your returns to compound over a long period of time!