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:

[table id=2 /]

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:

[table id=3 /]

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)?