Here’s Why You Should Dollar-Cost Average Your Investment

Here’s Why You Should Dollar-Cost Average Your Investment

This year, the Malaysian stock market hit an 11-year low due to coronavirus fears, and then surged upwards the next month. Overseas, the US stock market reached a record high, experienced its biggest drop and then subsequently rebounded – and that’s just in the first six months.

As an investor, it can be tough to watch your portfolio experience these extreme highs and lows. It can also make you question your investment strategy – you’ve always been told to invest as early as you can for retirement, but how do you invest in uncertain market conditions?

The wrong way to invest

First, let’s look at how you shouldn’t invest.

Johari, who just started investing last year, has a small portfolio in the local stock market.

However, he watched his portfolio anxiously as it experienced losses in 2019. When the stock market hit a steep decline in February and March this year due to COVID-19 fears, he panicked. Afraid that the stock market would decline further, he sold off his portfolio to cut his losses.

Soon after, the stock market began to rise again. At first, Johari wasn’t sure about buying back in, as we were still in the middle of the coronavirus pandemic. But when the stock market kept rising, he didn’t want to miss out– so he bought back into the stocks that he had previously sold.

In the example above, Johari invests based on whether he thinks the stock market will go up or down. But this is risky and can lead to investment losses.

What’s wrong with timing the market?

Investing based predictions of stock market movements – known as timing the market – doesn’t work for most investors. Here’s why:

  • The stock market is hard to predict. Investing based on how you think the stock market will move is risky, because it’s so hard to predict. There are many factors involved, including company valuations, economic growth, interest rates, political stability and investor confidence. Right now, things are even more uncertain as we’re grappling with the economic effects of the coronavirus pandemic and ongoing trade disputes between China and the US.
  • Buying at the bottom can still lead to losses. Over the long run, stock markets tend to move on an upward trend. So even if you could predict when the stock market will hit rock-bottom prices, waiting to buy the dip could cause you to miss out on gains in the meantime.
  • Emotions make us irrational. When your hard-earned money is on the line, emotions can make it hard to decide when to buy or sell. Fear influences people to sell when stock prices fall, and greed makes people buy when prices rise again – but buying high and selling low isn’t a great investment strategy.

That’s not to say that timing the market never works. Some investors use stock valuation metrics or technical indicators to determine if they should buy or sell. But it requires discipline and advanced investing knowledge. And since the market is unpredictable, even great market-timers can get it wrong.

Here’s where dollar-cost averaging comes in

If timing the market doesn’t work, what does? The answer is the dollar-cost averaging strategy.

The dollar-cost averaging strategy involves investing a fixed amount of money at a fixed schedule (e.g. monthly or quarterly). It doesn’t matter if the stock market is rising or declining – you just stick to the schedule.

Here’s why dollar-cost averaging works:

  • Avoid entering the market at the wrong time. By spreading out your investments over time, you’ll minimise the risk of investing all your money when prices are at an all-time high.
  • Avoid emotion-based investing. By investing a fixed amount of money on a schedule, dollar-cost averaging prevents you from making emotionally influenced adjustments to your investment strategy.

This can be a powerful approach when the stock market is declining. It helps you invest when prices are low, during a time when other investors may be staying on the sidelines out of fear. This sets you up for larger gains when stock prices recover.

Lump sum investing versus dollar-cost averaging

How does lump sum investing (i.e. investing all your money at once) compare to dollar-cost averaging during a volatile market? Let’s compare investing a lump sum of RM10,000 into Fund A, compared to investing a quarterly sum of RM2,500 into the same fund.

 
Lump sum investment
Dollar-cost averaging
Date
Investment amount
Unit price
Units bought
Investment amount
Unit price
Units bought
Jan
RM10,000
RM1
10,000
RM2,500
RM1.00
2,500
Apr
RM2,500
RM0.80
3,125
July
RM2,500
RM0.60
4,167
Oct
RM2,500
RM1.20
2,083
Total
RM10,000
RM1
10,000
RM10,000
RM0.84 average cost per unit
11,875
Comparison of lump sum investing against dollar-cost averaging. Figures are for illustrative purposes only

In this example, you’ve invested during an inopportune time, right before the price of Fund A starts falling continuously. However, its price picks up in the last quarter of the year.

With dollar-cost averaging, you’ll be able invest in more units when its price falls. When its price recovers, you’ll have a larger capital gain. For example:

What would be your capital gain if Fund A rises to RM1.50?

 Lump sum investmentDollar-cost averaging
Investment costRM10,000RM10,000
Units bought10,00011,875
Portfolio value
(RM1.50 x number of units)
RM15,000RM17,813
Capital gain
(Portfolio value – investment cost)
RM5,000RM7,813

As such, the dollar-cost averaging strategy can help minimise risk when markets are volatile or declining.

Focus on the long run and your long-term investment goals

As you practise dollar-cost averaging, don’t be swayed by the short-term market movements. The stock market will fluctuate year by year, and it may face crashes and booms. By keeping invested over many years, you’ll have a better chance of riding out these volatilities to reap positive returns. It’s also helpful to remember what you’re investing for, such as your retirement.

Invest in funds, not individual stocks

However, even dollar-cost averaging can’t save your portfolio if you choose bad stocks. This is why doing your own research before investing is extremely important. If you are not confident of picking the right individual stocks, consider investing in unit trust funds. This allows you to diversify your portfolio and spread your risk across many different types of investments. You can even use your EPF savings to invest, so you can diversify your savings without withdrawing additional cash.

Right now, it’s never been easier to diversify your retirement savings. The Employees Provident Fund (EPF) recently reduced its upfront fees for its online investing platform, EPF i-Invest, to a 0% sales charge. The fee reduction is valid until April 30, 2021. This means that you won’t incur upfront charges for dollar-cost averaging into unit trust funds.

But which funds should you consider?

Principal Asset Management (Principal) has a range of EPF-approved unit trust funds to suit different risk profiles:

 

Investment risk profile

All investments involve risk. Visit www.principal.com.my to access these unit trust funds’ prospectus, highlight sheets and annual reports for more information about the risks involved.

In conjunction with the first year anniversary of the launch of Principal EPF i-Invest, Principal is rewarding all EPF i-Invest’s investors from now until 9 September 2020. Invest a minimum of RM2,000 to be eligible for a Touch ‘n Go reload pin:

Invest and get rewarded

Click here for campaign details, terms and conditions.

With unit trust funds and a dollar-cost averaging strategy, you’ll be able to minimise your investing risk during these volatile times – so that you can maximise your chances of a comfortable retirement.

Follow these steps below to take charge of your retirement portfolio and get rewarded.

Invest with Principal and EPF i-Invest

Click here to find out more about Principal and EPF i-Invest.

Leave your comment