What You Need To Know About Dollar Cost Averaging In Today’s Market

Been a week since I have last posted, to my readers here, my sincere apologies as I was preparing to get my papers in General Insurance done. Luckily for me, I was able to clear the Basic Insurance Concepts and Principles (BCP) and Personal General Insurance (PGI) in one sitting!

What this mean is that I can recommend other range of products (Motor insurance, especially) on top of the usual life insurance products. 🙂

Beside that, I have been consulting a few clients in the area of investment and was able to convince them on the importance of Dollar Cost Averaging (DCA) in today’s kind of market (down, down, down and hoping for a up soon?).

So are you using this concept to your advantage or are you still scratching your head over the meaning and significance of Dollar Cost Averaging? I hope to clear this with this post.

The Meaning Of Dollar Cost Averaging

To explain the meaning of Dollar Cost Averaging to my clients, I will always explain in simple terms like when prices are low, you buy more units; when prices are high, you buy less units. With this kind of constant buying, you bring down or average the value of prices down, e.g. Price of $5 and Price of $3, the average is $4 now and when the market is at $4.50, you are already in profit of $0.50 per unit share.

If this is still confusing to you, then think of this “Fish-Ball” concept:

Imagine that you like to buy fish ball every month and is willing to set aside only $1 per month to buy. The current price for a fish ball is also at $1 each. Therefore with your $1, you can buy only 1 fish ball.

Therefore your $1 = 1 fish ball

But suddenly due to an economy downturn, the prices of everything start going down and your $1 fish ball is now $0.50 each. Whereas with your usual $1, you can get more fish balls like in this case:

Your $1 = 2 fish ball (at $0.50 each), so total invested is $2 for 3 fish balls

When the economy starts picking up, your $0.50 fish ball is restored back to $1 each.

So you $1 = 1 fish ball, so the total invested amount is $3 for 4 fish balls.

If you are to sell off your 4 fish balls at $1 each (please disregard the acutal possibility of selling fish balls at your own accord), your actual return from this sale is $4. From the initial investment of $3, you have made a profit of $1 ($4 – $3).

If you are clear about this fish ball concept, you are slowly grasping the real meaning of the benefits behind Dollar Cost Averaging.

With this in mind, will you like to take a personal test to see if you are ready to tap on the concept of Dollar Cost Averaging to help you make your money work harder?

There are three graphs that are very typical of an investment chart below:

Share Prices Are Going Up, Up and Up...
1. Share Prices Are Going Up, Up and Up
2. Market is Going Down and Up
2. Market is Going Down and Up
3. Varying Market Trend
3. Varying Market Trend

Take your pick and decide for yourself, in which investment chart will you be able to fully utilize the concept of dollar cost averaging and make your monthly saving work to the full benefit?

If you like, you can work it out on your own, based on $100 per month, for a full 12 months, prices varying (you can click on the image to get the different prices), and based on your total investment, how much returns will you be getting. If you are ready to for the answer… read on..

The Analysis

If you have chosen Chart #2 or Chart #3 as one of your choice for being the most profitable for your monthly investments, you are well on the way to being richer!

In fact, based on actual calculation, the most profitable will be Chart #2. The reasons for being the most profitable are that:

  • The last month that you sell off is higher than the first month that you have bought
  • There is a decline in the market, whereby your monthly investment amount during this few months, help to get more units for you (the fish ball concept)
  • You have started monitoring this Down Up Trend, and sell off when the price is on its high.

Also to note, you can also profit much from Chart #3! In fact, the reality of a real-time investment chart belongs to Chart #3. This serves well for those who don’t wish to monitor much and just wish to let the concept of Dollar Cost Averaging works its magic through the longer years.

For those who have chosen Chart #1, do not be dismayed that your answer is not the right one. Though this kind of chart do not really exist much in any investment, should this ever happen, you will profit the most, not from Dollar Cost Averaging, but rather from a one-step investment scheme.

To understand and fully benefit from Dollar Cost Averaging, you can actually do up your own appreciation, using the values of your preferred investment funds and plot them using the Microsoft Excel Spreadsheet, which you can also download here for your reference (right click and save as).

In summary, Dollar Cost Averaging is one of the investment strategies that you can use today to help your money (monthly investment mode) to work harder without having to worry much on the market movements. This concept may even work better when the market is down (like today’s context) by buying more units when the prices are down or to average down the initial high cost (when you first go into the market) with the ongoing months.

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