One Investor’s Issue with Dollar Cost Averaging
Introducing Dollar Cost Averaging
The concept of Dollar Cost Averaging proposes that a person who can afford to invest $10,000 each month should buy stocks each month regardless of price. In my limited experience, I have found that Dollar Cost Averaging works more to the advantage of my Broker than it does for me.
I have lost support for the popular idea of Dollar Cost Averaging (DCA) as it relates to investing on the stock market. The (relatively) simple reason is this:
Let’s Look at an Example of Dollar Cost Averaging
Let’s take a (not so) hypothetical situation, let’s take the guy up above with his $Ja 10,000 per month to invest. At the time of this writing, 1 $US = ~125 $Ja. Let’s say this investor is looking at a stock in month . If the stocks are selling at $1.00, the person would be able to buy ~9,600 units (accounting for ~4% in fees).Let’s suppose that in month number two, the same stocks are at $Ja 2.00, the person would be able to buy ~4,800 units, all things being equal. Now, let’s say that in month 3, the stock falls back to $1.00, he is again able to purchase 9600 units (having realised a loss of 50% on those he bought at $2.00 as well as the capital appreciation on those originally purchased at $1.00).
Note that, this actually puts the account in the RED since he would have averaged up on each unit by buying less units at a higher price. Further to that, he will again be getting less units (averaging up again) if he were to make a purchase when at a time when stocks have risen even further. By the way, a general rule of thumb in investing is to AVERAGE DOWN on your positions, not the other way round.
My limited experience in the real world has taught me that it is much better to find the intrinsic value of the stock, to buy it when it is below that value and to keep my cash in my pocket once the price is above the intrinsic value. I’ve found that Dollar Cost Averaging only works if you are buying the stock at the same price or less, and even then, returns are undermined by the fees incurred from buying the stock in multiple transactions. This effect though can be negligible if the stocks are held for a sufficiently long period and the market value of the shares actually improve considerably over that period.