[Investing] Time to Double Down for Dollar-Cost Averaging?

Hi there,

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

Total units accumulated in an active approach is abt 25% more than the passive one, even though the active approach would have invested about 22% more.


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

This approach significantly reduces the average price, but it also involves significant investments.


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

[Investing] The Time for Value Investing Is Here

The Straits Times Index shed 15% from 3220 a month ago to 2637 today. Many stocks are on discount.

Take for example, DBS was in the $25 range. Now it is $19.35. That is more than 20% discount!

At the current price,

• DBS has a market cap of about $52B (it was $56 when I started monitoring it when the index started to fall). I've learnt its probably more prudent to buy larger cap companies.
• DBS has a P/BV of 1.01 and ROE of 12% and ROA(ssets) of about 1%.
• Its profit margin is 42% (woah!)
•  Dividend yield is 4.2% (5-yr average)

With those stats, I think the current price of DBS is very attractive. I valuated it to be about $22 then. I bought some at $21.60 (including fees).

Has the stock reach the bottom? I do not know. 

But this is not the point of this post. The point of this post is to re-visit the principles of stocks-picking, especially at times like this where prices are low and people are panicking because the prices are low.

Not for a value-investor. This is the time to hunt. The basic principles apply. A good stock has:

• Profitable business
• Good financial strength
• Good cashflow

It boils down to two words: Strong and Efficient. The pre-requisite, however, is consistency.

I aim to find stocks that exhibit characteristics of the basic principles. I cited DBS because I think it fulfill those principles (correct me if I am wrong!).

It is easier to judge whether a stock possesses the basic principles. But is is harder to know at what price should one buy the stock if it has been determined that is a  steal?

I used to think:

• What if the stocks drop further, so I can get a better bargain?
• What if the stocks increase and I missed the chance?

I learnt that I can mitigate this by:

1. Split the investment funds into half. 
2. For the first half buy at the price which I determined to be a good value*.
3. For the second half buy only when the price is substantially lower than the value I determine**.

This way I can lock down my optimal value. If the stock price goes up, at least I have gotten into a position that I think is favorable. If the stock price goes down, I can wait longer and then get into another position again, so than on average the stock price I buy at is lower than the price that I valued. This is my form of managing risk I suppose.

However there are many subjectivity. What is good value? What is substantially lower? This will require some education, experience and emotion-management. 

• On education. Reading helps. I have a curated a reading list in this blog. Read about how stocks are valuated, but do not get sucked into fancy valuation models; simple is great. Learn about risk management. Valuation models that do not address risks should be avoided. Valuation is also subjective; nobody can really pin-point the true value of a stock. And because of this, the value of a stock can also be assessed relative to another stock in terms of efficiency. If stock A is 3% return on Assets and stock B is 5%. Which is more valuable? I prefer to think of it as fair price and efficiency.
• On experience. I watch the stock market perhaps once every quarter? But I do take note of news because I know how the media can affect the markets. I personally buy STI ETF on a RSP basis. Knowing the market helps - how much a stock would max at. Some of my friends use the middle-point of the 52-week range to gauge whether a stock is selling at a discounted price. It is probably a good start. P/BV is probably also another good starting point. DCF too. But that said one should not be sucked into the mania of the media and the markets.

This sale has just started. So it is a good time to do some evaluation and buy stocks when the prices are right.

~ZF

Warren Buffett and Charlie Munger are my heroes.