Take Advantage Of The Volatile Market Through Dollar Cost Averaging

For the past couple of weeks, some Asian currencies have been hit pretty badly and the Singapore dollar climbed to record highs against many of our neighbours’ currencies. Since I go to Johor Bahru pretty often, I took a leisurely walk to Change Alley during lunch time last Friday to check out the exchange rates. Unfortunately, most people thought the same way too and the place was super crowded.

Singaporeans definitely know a bargain when they see one. 😛

Apparently, this bloodletting is due to big institutional funds withdrawing their funds from Asia. And obviously, the stock markets have not been spared. It was a sea of red for many Singapore counters last week. The queues at the money changers probably doubled after the Sing dollar appreciated by about 5% against the Malaysian Ringgit in the past 3 months. So Singaporeans should be investing more since Mr Market is currently giving a 10% discount on the STI (if you compare it to STI closure of 3454 on May 22), isn’t it? Yippee!

However, our local newspaper urges caution. This is what I picked out from yesterday’s The Sunday Times Invest Section:

First article:

With the proposal to reduce the size of 1 lot from 1000 to 100 shares, investors could find it easier to cough up the capital to purchase some blue chip stocks. However, blue chips are no guarantees towards investment success. You could have lost quite a bit of money if you invested in SMRT or NOL or even Wilmar. Even if you bought the businesses with good prospects, you could time your purchases badly and suffer a loss. Best to proceed with caution.

Another article:

All of us should have sold all our equities three months ago when the market was at its peak! But what now if we had missed the boat? Should we continue practicing what Buffett keeps telling us and stay invested? Or perhaps we could sell all our equities and conserve cash to see if cheap becomes cheaper. Otherwise, we could explore alternatives like gold, CPF accounts or properties.

Just a couple of months ago, these investing columns were raging about the undervalued equity markets and the allure of Reits but all of a sudden, it’s about exercising prudence. The mood has changed. Instead of preaching about the historical 10% annualised return that one should be getting on average, experts are now informing the masses that there is a real possibility of losing their pants in the market.

And many new investors are getting cold feet, with comments like “With the latest turmoil, is this the right time for me to start investing?” and “It’s better to observe this crisis unfold before I start my passive investing program”. Yes, there is a chance that we could see further corrections of 10/20 or even 30% in the markets. I also know that you probably won’t feel too good seeing your first $100 in the POSB Invest-Saver lose 10% of its value. But there’s also a good chance it might just bounce back after a week?

In a perfect world, the STI and all stock prices would jump by 1% a month and everybody would receive the same high returns of >12% every year. We wouldn’t have to worry about timing our purchases. However, in reality, when we invest in the stock market, we have to accept the volatility that comes along in the same package as the profits.

And since you can’t avoid it, why not embrace and take advantage of volatility’s characteristics through dollar cost averaging.

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Let me explain with a simple illustration:

Suppose I have $600/month to invest in Sep, Oct and Nov and would like to liquidate the investments in Dec. There is this quality ETF/stock named Z that I am interested in.

Scenario 1:

SepOctNovDec
Price of Z$5$5$5$5

The price is stable at $5 throughout the entire period. I would be able to buy 120 shares in each of the three months, accumulating a total of 360 shares. Selling these shares at $5 in December, I  recoup back the same amount I put in: $1,800.

Scenario 2:

SepOctNovDec
Price of Z$5$4$6$5

In this scenario, the prices are volatile and fluctuate by $1 each month (at least 20%) each month. I would buy 120 shares in Sep, 150 shares in Oct and 100 shares in Nov, accumulating a total of 370 shares. Selling these shares at $5 in December, I would earn a profit of $50 from the additional 10 shares!

Wonderful, isn’t it? The prices at entry and exit are the same but I managed to turn in a profit for Scenario 2. This is the advantage of dollar cost averaging. Some semblance of market timing is already built-in into this system that capitalises on volatility. By committing to a fixed amount of investments every month and not investing everything at one go, I am buying less of the stock when prices are high and vice versa. 

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So instead of trying to ask an expert when to invest, perhaps a better question would be to ask yourself if you would like to buy more of Z at a certain price, especially after a correction. (A big assumption for stock pickers here would be that the fundamentals of the business must remain sound.) This is fine-tuning the principle of dollar cost averaging to further boost our overall returns.

I purchased 8 lots of First Reit last week at a price of $1.035. It subsequently went lower to $1.02 within an hour. However, I wasn’t upset at all (even though that $120 could easily pay for my utilities bill). In fact, I was rather happy since I would have been very comfortable at any entry price <$1.05. And if prices do drop further, I am ready to invest further since I will always be holding some cash in reserve. You should, too. Otherwise, how are you going to continue to dollar cost average in your Regular Savings Plan (RSP) or invest more in corrections (just like me)?

 

 

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    6 thoughts on “Take Advantage Of The Volatile Market Through Dollar Cost Averaging

    1. Musicwhiz

      The key is to ensure that the Company itself is worth investing in when we do DCA. Frequently, we may encounter value traps or just plain duds; it would be very dangerous to do DCA on such companies as you would essentially be averaging down on poor fundamentals!

      As for the general sentiment, it is always good to invest in times of uncertainty or economic turmoil – that is the time when valuations will be attractive and you can find value with sufficient margin of safety. The problem is people equate uncertainty with “wait and see” – once the coast is clear and everyone is bright and cheerful, nothing will be cheap anymore. Herein lies the difficulty in investing.

      1. My 15 HWW Post author

        Yes, you are absolutely right. The fundamentals are the key. Even if the price is increasing, as long as it is increasing slower than the improvement in long-term business prospects, it’s still a worthy buy. However, I feel that this is the most difficult situation to judge and act on due to anchoring bias.

        What I am trying to point out is that a person is behaving rather irrationally when he is suddenly getting cold feet towards index investing after the market corrects by 10%. When you have committed to a RSP, investing should be similar to toothpaste buying. Since you are a perpetual buyer, why not just get more of it when it’s cheaper?

    2. Musicwhiz

      Thanks! Got your point – and the whole process should be mechanical, meaning with an RSP or DCA, you automatically purchase shares in and ETF or company regardless of market conditions or sentiment. Most people would find this tough – delegating the decision to a mechanical process. Somehow they may think they are more in control when they make the decision themselves – but this is a fallacy because you tend to get caught out by your emotions.

      Good post, keep it up!

      1. My 15 HWW Post author

        Hi Musicwhiz,

        Yes, with an RSP, you will automatically DCA and benefit from market volatility, as shown in the post’s example. Obviously, we can do better if we make a conscious decision to buy more if the prices has decreased (another 150 shares in Nov). This way, one can earn another $150 in Dec when we liquidate.

        If we take this reasoning further, one can argue that the best option is to wait till Nov and invest everything at one go, earning a return of 25%. This only seems simple on hindsight but is actually a fallacy (like what you had mentioned). Feel investors had the courage to showhand back in 08/09 when the STI was comfortably hovering below 2,000.

        Guess Level 2 is what I am aiming for. Buy slightly more when valuations are not demanding, and sell a little bit when markets turn frothy.

    3. B

      Hi HWW

      Contrary to most people, I usually turn to news from the paper to buy instead of sell stocks. I think when newspaper like the one you mentioned above have advocate selling and bring fear into the market, that is a round 1 level to buy for me. Of course this is all only generic and we still need to look deeper into the valuations of each company.

      Wow, you bought 8 lots of First Reits, that’s a lot for round 1. Hehehee, you must have plenty of ammo for the next subsequent rounds.

      1. My 15 HWW Post author

        Hi B,

        I prefer my bullets to be impactful to my portfolio. The smaller % of expenses I pay to CDP & my broker if I buy more at one go also plays on my mind. Furthermore, I generally don’t like to monitor the markets everyday.

        Since STI went down to <3000, I have fired another bullet yesterday. Instead of carrying some machine gun, I am probably holding a revolver that requires better aiming, so perhaps I don't have as much ammo as you think.

        I am probably betting that if the market goes down further, it won't be that fast & furious. I would then have some time to replenish my ammo for more shots. 🙂