[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] Comparing Dollar-Cost Averaging and Buy-Low-Sell-High (B.Lo.S.Hi) Strategies

In my previous post, I applied dollar-cost averaging (DCA) on Nikko AM STI ETF (G3B) on a 5-year time-frame.

Then a friend showed me an article about the fallacy of dollar-cost averaging.

Indeed, I mentioned in my previous post that dollar-cost averaging depends much on the point where the prices are; if one started low, the accumulation will be fast.

But the result of averaging is not average. At times when prices are low, units accumulation takes place. When prices are high, the additional units also contribute to the total value. Units are the one generating dividends too. In good times (prices are high), dollar-cost averaging suppresses costs. In bad times when prices are low, dollar-cost averaging helps consolidate units.

Dollar-cost averaging is a lazy-man style of investing in auto-pilot. It makes sense if investing costs are low. Obviously, it cannot do better than the Buy-Low-Sell-High (BLoShi) strategy, as I will show later. But the DCA has its merits over the BLoShi too, which I will also share my thoughts later.


DCA Vs BLoSHi. Fight!

I have extracted the maximum data (month) from Yahoo! Finance and coded up the following charts using Python. The hypothetical investing strategy is that I am investing $100 per month since 2009, when G3B debutted into the market.

As shown in the above chart, the average costs increases over time, but the rate of increase slows as time advances because of the large amount of units accumuated (not shown here). The points that are marked with a red 'X' are points when the actual price that is below the average price. These will be points in consideration for the BLoSHi approach.

The BLoShi Approach

In the BLoShi approach, funds are accumulated since the start and maximum units will be bought with all the funds accumulated when the price is below the average price of the DCA method. As shown, there are 5 points that mark this criteria. I shall assume that I enter at only two of these - the first (31-Aug-2011) and the last (31-Jan-2016).

The expected result is that this approach would definitely fare better than the DCA. As we shall analyse in the next chart.


DCA Vs BLoSHi. Performance

The following chart shows compares the value of the units held for the whole period in consideration.

The relevant numbers are:

With DCA,
Total Amount invested = $10,800 

Total Units Bought = 3839 

Total Value = $13,669 

Total Yield = 26.565% 

BLoSHi (Without DCA)
Total Amount invested = $8,400 

Total Units Bought = 3280 

Total Value = $11,678 

Total Yield = 39.027%

Due to the perpertual nature of the DCA, the amount accumulated in DCA is definitely more than the approach without - 600 more units as shown. The costs and holding value will also be higher.

Note that the analysis does not include the dividend yield.


A Simple Principle in Investing

"Buying Low and Selling High" is one of the principles of investing. "Buy a dollar for 50-cents". How low is low and how high is high? There are many metrics to determine that. For the lows, some use the 52-week low to gauge, the same is true for the highs. This form some-sort of a price resistance (I am not a trading pro BTW). Some use moving average over a certain period - if the price is below that MA, buy; if the price is above that MA, sell! Simple enough. Of course there is also the almost-mythical intrinsic value.

We may determine the intrinsic value, but we are able to make a best guess of it. Personally, I would say that numbers that are backed by fundamentals. i.e. there is a basis, is probably the more reliable one, because I cannot find satisfactory answers to question like:"How do we know if the price is going to break the 52-week high (or low)?", "How do we know if the prices will go lower even after falling below the MA?". To the latter question, one way is to keep buying, of course.


The Problem with BLoSHi

BLoSHi seems like a very sound investment strategy, I just wait out for the price to be low enough to buy and sell when the price is high enough. However, the investment strategy is oversimplified. Let's look at the statement again, this time I will italics the key words:

I just wait out for the price to be low enough to buy and sell when the price is high enough.

In essence, there is uncertainty in the price movement and the time. Firstly, I need to determine the price - how low/high is adequately low/high to buy/sell? In the above analysis, it is retrospective. It is easy to pin-point prices that are lower than a certain value (an yearly average, for example) on a historical price chart like the above. Again we can use various metrics (discussed above) to determine the price to buy with some confidence.

Next, when prices are live, and when it shows that the price is trending down after a peak, not many of us will be able to overcome the psychological barrier (fear, that is) or the discipline to buy even if it is near the low that we are waiting for. That is because nobody is certain where the price is going - is it going to bottom out? What if it crash?

Finally, holding out cash to wait out for the price to reach buying-low is not efficient at all. There are much opportunity costs to this approach. In the example above, it is more than 5 years between the two purchases (Aug 2011 and January 2016). Consider the amount that could have been paid out. Assuming that the price remains stable at $2.50, a monthly contribution of $100 will allow me to buy 40 units. In a year I would have accumulated 480 units, and 2400 units in 5 years. If each unit pays out 2% or 0.05cents dividends every year, I would have missed out on $360  of dividends in total, that is more than 3 months' worth of contribution.

With 2% dividend, the yields presented above will be about 29% and 39% for the DCA and Non-DCA cases respectively. As mentioned, the BLoSHi has forgone the compounding effect of any dividends.


Conclusion

Dollar-cost averaging is not a perfect investment strategy. Honestly, in my opinion, it cannot beat the market per se, but it helps to suppress costs when prices are high and accumulate units when prices are low. Here 'highs' and 'lows' are relative to the average price. It also helps one stay invested without the psyhchological barrier when prices dip, and it optimizes the effect of compounding. It also helps negate the need for large capital outlay. This way, we still can get back a fair share from the stock market even though the outcome may not be as stellar as the BLoSHi approach, which I shared that there are many barriers to apply efficiently. However, this is all in the pretext that the investing costs are low.

Perhaps, to optimize the results, one way is to increase the contribution when the prices are low. Maybe I shall leave it for another time.

Do feel free to air your comment!

~ZF

[Investing] Applied Dollar-Cost Averaging

In the previous post, I simulated the principle of dollar-cost averaging. Today I shall apply it onto real market data.

The data of interest is the Nikko AM STI ETF (G3B) that is traded in the Straits Times Index (STI). An ETF that tracks a broad-diversification index like the STI is similar to an index fund. Personally, I have invested in G3B via a regular savings plan, so this is also a little exercise for myself.

I have obtained 5-years' worth of monthly closing prices from Yahoo Finance for this exercise, and I will be investing $100 per month in the G3B. The effects of transaction fees are assumed to be negligible.


Price Vs Average Price

The average price is calculated by dividing the total amount invested by the units accumulated. The result is presented in the chart below.

As expected, the average price is smoothed and almost consistent. Consistent price = consistent cost. You may see that even with the very high price between Periods 50 and 60, the average price is still maintained.


Amount Invested Vs Holding Value

The following chart tracks the changes in holding value (the worth of the units that are bought and held) against the total amount invested.

You might have noticed that the portfolio started when the price is peaking, thus the Holdings Value exceeded the Amount Invested starting at about Period 15 because of the increasing prices, until at about Period 30, when prices began to dip.

Between Periods 30 and period 45 (this is slight more than a year, by the way), prices were suppressed, overall holding value declined too, but it was a good time for consolidating more units. As you can see, after everything recovers, the increase in holdings value is much greater, because of the consolidation period.

This is why we need to stay invested.


What if you started late?

It is never too late to start. I have also prepared similar charts for a 2-year investment period.

The trough period helps to consolidate units while the prices are suppressed.

From the charts, we see that thanks to the trough period, the holdings value exceeded the total amount invested quickly. Should an investor started 1 year later, at the midst of bullish price, he might not get that kind of performance. Instead, he might want to reduce (NOT stop) his contribution since the buying power has reduced, and increase only when prices are low again.

See, dollar-cost averaging works if one stays invested for a long, long time.

Feel free to comment!


~ZF