May 9, 2019 | Gaurab Subedi
If you are looking to invest in stocks and do not have a lump sum of money to invest at once, then dollar cost averaging comes as a solution to your problem. It is one of the well-known investment strategies which is similar to paying an EMI to repay your loan and principal.
Dollar cost averaging is an investment strategy where the investor is involved in investing a set amount of money at a regular interval for a period of time instead of investing all his money at once. For instance, you have 1 million rupees to invest in a stock market. So, if you opt to go with dollar cost averaging, what you can do is invest Rs.50, 000 for the next 20 months until you finish your set amount.
A simple investment strategy to make profits on your investment is to buy low and sell high. But you can never know when the market dips down and when it starts making an upward turn. You cannot predict the market with surety. Dollar cost averaging is built on a concept that you can reduce the average cost of the shares bought by buying more stocks when the price is low and fewer when they are high.
The price and the number of shares purchased are opposite in relation. As a result, DCA facilitates purchasing more shares when the share price is low and fewer shares when the price is higher. As a result, the average price per share has more chance of being higher than the average cost per share.
Dollar cost averaging also assures a win-win situation in the stock market. For instance, when the market falls gradually throughout the period of time, you can buy more shares at a low price. Similarly, when the price starts going high then this early investment will generate profit for you. So either the market goes down or up, you will find yourself in a merry situation.
Similarly, you can lessen your emotional stress by using the DCA method. When you invest a lump sum amount at once, a small fall or rise in the market will make you more anxious.
This technique is not always profitable but it can reduce the financial risk associated with losses. Also, if the time period is shorter then it becomes similar to a lump sum investment. A study in America in 2012 have also shown that lumpsum investment excels over DCA. Personally, what I recommend is to invest some amount as a lump sum investment too. Once you are confident about your portfolio, then you can use the DCA technique and invest a small amount on a regular basis.
To illustrate the impact of this strategy, let us take the time frame of the last 22 months where investors observed major downfall in stock price after the stock market faced a severe market crash.
I have considered an investment of Rs. 20,000 every month in 10 stocks from mid-June 2017 till March 2019 and tried to observe the difference in the number of shares holding at the end of the time frame. Since Nepse declined throughout the observation period, dollar cost averaging technique would have been profitable than the lump sum investment in this period.
If you have used DCA technique over lump sum investment in the declining market of Nepal, then you would have 101 unit more shares of Chhimek Laghubitta. Likewise, you would have 207 unit more shares of Surya Life Insurance if you have favored DCA.
The basic rule of investing is to invest sensibly and by realizing the value of the stock. Adopting any sort of technique in the absence of good fundamental analysis of a company becomes a failure. So, either you choose any of the above techniques, what matters the most is to pick good stocks and give time to those stocks to get healthy returns in your investment.