I wrote a couple of posts on dollar-cost averaging, and with the current economic climate, with the STI shed more than 30% in value over 2 weeks, I thought it might be a good opportunity to relook at this investing strategy.
Recap: Dollar Cost Averaging (DCA)
This is a simple investing strategy where one invests a fixed amount of money periodically. The volume bought varies with the going market price, but the total value is fixed by the amount of money invested.
For example, if $100 was invested every month to buy a stock that was going for $2 each, 50 units ($100/$2) of that stock would have been bought. If the price of the stock increased to $2.20 each, 45 units ($100/$2.20) would have been bought.
Over time, a number of stocks will be accumulated and the average price can then be computed. This average price tends to fixed value a long period of time, assuming there are no changes to the periodic investment amount.
The simplest application is the Regular Savings Plan on a STI ETF like the Nikko AM STI ETF (G3B).
Recap: What Happened?
COVID-19 has created much uncertainty in the markets, as countries implement lockdowns and restrict movement.
As a result, everything looks insanely cheap. For example, DBS is now about $18 compare to about $25 a month ago. STI is now at about 2,440 points, compare to 3,158 a month ago. In terms of ETF, this means the price of STI ETF has fallen from approx. $3.15 to approx. $2.44, or about 22% decrease.
Two Different Approaches to DCA
There are two approaches to DCA: a passive one and a active one.
The passive approach is a fire-and-forget strategy. One just sets the amount to invest periodically, and forgets about it. No watching of the market. No worries.
The active approach is to increase the investment amount every time the market price is lower than the average price of the portfolio. In this way, more units could be bought when the prices are low. That in turn will reduce the average price in the portfolio.
The analyses do not consider re-investment of dividends.
Comparison
I compared the two strategies using monthly data from Yahoo! Finance, starting from 1 March 2009, since the inception of G3B into SGX.
For the passive strategy, I used a monthly investment amount of $100 and determined the number of units I would be able to buy with that amount. I then computed the maximum portfolio value, total number of units accumulated and the average price per unit.
A similar approach was used for the active strategy, except that when the going price was below the average price, the investment amount would be increased by a factor. For the simplest case, I set the factor to 2 - if the going price was below the average price, I doubled the investment amount to $200. I would simulate factors 3, 5, 10, and 100 also.
Results
Total Units Accumulated
- Passive = 4,299
- Active = 4,830
Toal Invested
- Passive = $13,203
- Active = $14,701
Average Price
- Passive = $3.07
- Active = $3.04
The passive approach is generally fine. The average prices is generally below the price. The passive DCA is a sound strategy.
The difference in the average prices between the passive and active strategies may not look significant, but the number of units accumulated is. The active approach accumulates 12% more units, at about 11% more costs.
This additional volume has another advantage. Since each unit is entitled to dividends, more units means more dividends received. Over time, the difference will be significant.
Now, lets look at the effect if the factor is increased to 3.
Factor = 3
This approach triples the amount invested when the average price is below the market price.
Total Units Accumulated
- Passive = 4,299
- Active = 5,362
Toal Invested
- Passive = $13,203
- Active = $16,202
Average Price
- Passive = $3.07
- Active = $3.02
A More Radical Approach?
A variant of the active approach is to buy the number of stocks already accumulated, that is double the portfolio size, when the price is below the average price. The factor applied is 1.
The results:
Total Units Accumulated
- Passive = 4,299
- Radical = 35,262
Toal Invested
- Passive = $13,203
- Radical = $91,165
Average Price
- Passive = $3.07
- Radical = $2.58
Conclusion
DCA is a passive fire-and-forget investment strategy. It leverages on time to amass large number of units. It by itself is a sound investment strategy.
However, if the market remains bullish for an extended period of time, the averaged price will usually tends toward a higher side, unless there is a prolonged bear market.
It is possible to optimise the strategy by taking a more active approach. When the market price is lower than the average price, more units could be bought so that the average price is lowered. In this post I used multiples of 2 and 3, doubling and tripling the investment amount when the condition is fulfilled. I also shared a more radical strategy where we double the portfolio size when the condition is fulfilled.
The idea of active intervention, regardless radical or not, is to amass as many units as possible when prices are low (compared to the average).
Perhaps now is the favorable time to re-look at your porfolio and see if you are able to make full use of this opportunity. Personally, I have managed to averaged down my portfolio to $2.85 (from $3.31).
If you have not started investing. This is one of the best times to start. Of course, work out your insurance and make sure you have enough liquidity first.
Start small but stay invested.
~ZF
