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Financial markets are always volatile. Investments in equities have both advantages
and disadvantages, depending on a myriad of variables such as economic and political
considerations. As an investor, you cannot expect to ride on the bulls all the time
and you must be prepared for market turbulence - when the bears stampede the bulls.
In a volatile investment environment, discipline and skill is required to make
consistent returns. Real trading requires more than simply reading all the books
and articles on investing. Good judgment is a key aspect of investing.
The motto says buy low and sell high. Sounds easy but in real life, how often do
investors achieve that? Frequently, investors end up buying high and selling low
instead.
Often when you start investing, you find yourself buying in at the top. This is because
when the market is rising, the temptation to follow the crowd is irresistible. Then
the markets tumble. When the market drops, people naturally want to get out. You
join in the frenzy sell right smack at the bottom.
Basically, you do not rush out to sell a stock with sound fundamentals and long-term
growth prospects when the price starts to fall. Neither do you rush to buy a share
when its price is at its all time high. When the market hits a low spell, smart investors
would consider buying even more shares - at bargain prices.
The test of smart investing is knowing when to buy or sell. One of the proven ways
to protect your investment is by investing regularly adopting the dollar-cost averaging
method.
How do you avoid such risks of buying high and selling low? Is there a way to
enjoy the advantages of having investments and still get a good nights sleep? Investors
who do not wish to be stressed by market volatility adopt dollar cost averaging method
for secured long-term investment planning.
The term sounds complex but there is really nothing mystical about the strategy.
Instead of investing all your money in one go, you invest a set amount of money at
regular intervals quarterly or monthly for example regardless of market swings.
By adopting dollar cost averaging, you will be less tempted to make decisions based
on short-term phenomena. You benefit from market swings in both ways. Your future
growth will not depend on only one call whether to buy or sell.
This approach is best viewed as a method to separate emotions from the investment
processes. Instead of trying to time the market in response to greed or fear - two
most common emotional influences, you invest on an installment plan knowing that
your money will grow over the long-term. The method employs discipline not emotions.
Dollar cost averaging works for almost any type of investment - individual stocks,
bonds and even unit trusts.
The rationale is, - steady investments lets you purchase more shares when the
prices are low and less when the prices are high. In other words, you even out the
risk of buying at the peaks and selling at the bottoms. The technique does not automatically
guarantee a profit or protect against a loss, but it usually results in a lower average
cost per unit over time.
Consider the following hypothetical example. Mr. X adopts dollar-cost averaging and
has been buying share A regularly at a constant amount of RM200 per month over the
entire period. Mr. Y, short-term market pundit, invests irregularly on the basis
of tips and rumors. He invests at one time all his money on the same share A in Period
3. Refer to Table 1 for details.
Table 1. How Dollar Cost Averaging Works
|
Mr. X (long-term investor)
|
Mr.Y (a punter)
|
|
Period
|
Monthly
Investment
|
Share
price
|
Share
bought
|
Monthly Investment
|
Share price
|
Share bought
|
|
1
|
200
|
6
|
33
|
-
|
6
|
100
|
|
2
|
200
|
10
|
20
|
-
|
10
|
|
3
|
200
|
12
|
17
|
1200
|
12
|
|
4
|
200
|
9
|
22
|
-
|
9
|
|
5
|
200
|
6
|
33
|
-
|
6
|
|
6
|
200
|
8
|
25
|
-
|
8
|
|
Total
|
1200
|
51
|
150
|
1200
|
51
|
100
|
| Average price over a six-month period |
8.50
|
8.50
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| Average cost over a six-month period |
8.00
|
12.00
|
Value of investment
(current price times total shares) |
1200
|
800
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Source: Normandy Research
* Amounts in RM
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