Regardless of timeframe modelled, the picture remains that DCA, while not completely eliminating the impact from market volatility, provides investors with a smoother ride even as fortunes swing. This enables investors to breathe easier, and greatly reduces decisions driven by emotions, which could be very costly.
Imagine what must be going through the investor’s mind in April 2009, if he had Portfolio 2, on a lump-sum investment in 2008? His right brain will be making a big push to have him exit the market altogether, and take a big loss. He would be much more likely to make the wrong decision if he were a Portfolio 2 investor.
While a Portfolio 1 DCA investor will generate lower returns over both the 6 and 12-year periods, he can actually park his funds in low-risk instruments (like short-term bond or cash funds), and release them every year for his DCA mechanism. The returns from those low-risk instruments can help narrow the gap against the returns from Portfolio 2.
A case can also be made for using DCA for someone who has not saved a lot of money. He can invest gradually, thereby participating in the financial markets on a DCA basis, rather than having to take time to accumulate large amount of savings before a significant lump-sum investment.
Now that we understand DCA can lower the portfolio volatility, we are left with the task of evaluating where and what to invest in, which should be dictated by our risk profile. Some types of funds lend themselves better to the DCA method than others. When we utilise DCA and construct a portfolio aligned to the risk profile, we invest within our comfort zone, and we are flattening out volatility.
Therefore, I have created this Investment Risk Profiling Tool for DCA Suitability to help you understand your risk profile, and in turn, which categories of funds are suitable for you as an investor. Click HERE to download the Investment Risk Profiling Tool for DCA Suitability.
Investors often try to time the market, and place big bets (either upon entry or exit), and invariably, that depends on good judgment, a huge dose of luck and emotion. By investing on a DCA basis, we reduce the significance of these factors. We invest like a robot. It is a fallacy that we can buy at the lowest point and sell at the highest, lump-sum. We will not know when or where they are.
For those with a very strong stomach for risk and volatility, they can invest lump-sum and potentially reap higher gains over the long term. However, for most others, the DCA method provides solace. DCA enables us to buy low, sell high. We only need to believe that markets eventually trend up and recover from blips. With the current malaise we now face, and the uncertainty lording over financial markets, DCA is now more relevant than ever.
And, for the record, my left brain won that discussion in the lift.
Article by Leon Loh
The writer is a financial adviser representative representing GEN Financial Advisory Pte Ltd