Is Dollar Cost Averaging/DCA for You?

Photo by Susan Yin on Unsplash

Author: Andrew Lee
About 3 minutes read.

You may heard about DCA, aka Dollar Cost Averaging. This is the basic concept to spread risk across a period of time to smooth out the risk (swing up and down in the market) to lower the unit cost. Here is a simple illustration to show how investments are spread out into several lots over a certain period of time, just for those that hate numbers 😆, the fix invested amount over 9 purchases fluctuate according to the stock market price of that day. You can see the purchased share # as the blue bar. The red line is the market price fluctuating on a daily basis, and the orange line is the average cost of share over time (accumulative).

This is the tabular view of the above chart.

It is a strategy to mitigate timing risk. However, it is not the only method. You could combine with other strategies such as the candle sticks, moving average (MACD), Fibonacci retracements, RSI (Relative Strength Index), or even as simple as dividend payout date depending on your risk tolerance and appetite. Please also notice the trailing line edging downward. DCA does not guarantee your average purchased share price is always lower than the market price. If the market continue to trend downward, it could be lower than the average purchased share price.

However, is DCA the best method? You could argue that for someone who just simply invest in S&P 500 index overtime for the pass 20 years as oppose to another investor who invests in a single stock or has been actively trading, the outcome varies. Of course, this example is in fact misleading, and I hope you did spot this. S&P 500 index is a blend of weighted companies from various industries and sectors that implies diversification for large-cap US companies (physically located in US and doing business in US, but does not mean it is 100% US owned). Don't confuse this with ETF. Here is a break down from Jan 29th, 2021 from https://www.spglobal.com/. I have also provided the link in the reference section that will provide more information if you are interested.

Does this mean DCA fits better for index fund? or funds that have diversification in a specific industry/sector (e.g. ETF)? or a single stock? In my opinion, there is no best fit, however, it is a strategy that applies to your risk management strategy (asset allocation, a blend of volatility, your capital and income, etc.) and it is not directly related to the security itself. The major concept is to mitigate timing risk, and that is it. Most investors prefer buying low and selling high or vice versa for shorts, or some sort of value investing, and DCA is one strategy to utilize your capital overtime instead of one-shot at a certain time. You do want to understand how you reallocate assets or capital when it comes to DCA, and the time horizon how long you would hold the positions, and your exit strategy.

In addition to DCA, a little tip here, if you notice a few index fund (e.g. ETF) that are highly concentrated on a few stocks that you have, you could consider tax-loss harvesting with existing equities in your profile to avoid wash value. Yet, just another strategy.

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References

https://www.spglobal.com/spdji/en/idsenhancedfactsheet/file.pdf?calcFrequency=M&force_download=true&hostIdentifier=48190c8c-42c4-46af-8d1a-0cd5db894797&indexId=340