Explain how investing a fixed amount each month works, and what it can and cannot promise.
Nadia made her first investment a week ago. Since then she has seen a post in a finance group, with hundreds of likes, saying dollar-cost averaging means you can never lose money as long as you keep buying monthly, and because she already plans to invest monthly it sounded like good news to her, though also too good to be true.
The post is wrong about that. Investing a fixed amount on a regular schedule is still a sound habit, and it is the plan this module builds. Dollar-cost averaging has a specific job, and if you know where that job ends, you won't expect the wrong thing from it during your first bad year in the market.
Dollar-cost averaging (DCA) is investing the same dollar amount at regular intervals whatever the price, so you buy more units when prices are low and fewer when they are high. To do it, you choose a fixed amount, invest it on a fixed schedule regardless of the price, and accept that the number of units you get will change from one purchase to the next.
Say you invest S$500 a month for three months. In month 1 the price is S$5.00 and your S$500 buys 100 units. In month 2 the price is S$4.00 and your S$500 buys 125 units. In month 3 the price is S$5.00 again and you get 100 units. You have invested S$1,500 and you own 325 units.
To find your average cost, divide the total money invested by the total units you own: S$1,500 / 325 = about S$4.62 per unit. Compare that with the simple average of the three prices you paid, which is about S$4.67. Your cost per unit comes out lower because the fixed amount bought more of the cheap units without you doing anything. At the month-3 price of S$5.00, your 325 units are worth S$1,625.
None of this needed a prediction from you. When the price fell, the extra units you bought while it stayed low made up for part of the drop.
The arithmetic helps, but regular investing is mostly useful because it builds a habit. Most people are paid monthly and can invest monthly. When you invest a fixed amount on a fixed date, it becomes a routine like paying a bill, and you stop having to decide each time.
Deciding is where people tend to go wrong. If you choose each month whether to invest, you are likely to hold back when prices are falling and the news is bad, and those are the months when your fixed amount buys the most units. A standing plan takes that choice away.
You don't have to invest every month for this to count. A fixed amount invested less often, such as quarterly, is still regular investing. In lesson 1.4 Nadia set up a plan to suit her broker's fees: she saves S$500 from each pay cheque into her bank account and buys every three months, which makes S$1,500 a quarter.
DCA does not prevent losses. If the market keeps falling for a year or two, each new purchase is worth less than you paid, and so is everything you bought before it. Buying more units at lower prices helps your portfolio recover faster once prices rise, but your balance still falls for as long as prices stay low. A person who started investing monthly just before a long decline could see a balance below their total contributions for years.
DCA also does not find a good time to buy for you. It spreads your purchases across good and bad periods, so you avoid putting everything in at the worst moment, and you also give up the chance of putting everything in at the best one.
Investing from salary each month and investing a lump sum are different situations. A lump sum is money already in hand that you have decided to invest, such as a bonus or savings. Nadia has done both. In lesson 6.4 she invested her S$5,000 starting amount in one go, and her future S$1,500 orders will come from her salary. She has now received a year-end bonus and hasn't decided what to do with it yet.
You can invest a lump sum all at once or spread it over several months. Over long periods, markets have risen more often than they have fallen, so investing a lump sum straight away has often finished ahead of spreading it out. Money waiting in cash misses any rise for as long as it waits.
Take the same fund while its price climbs steadily. If you invest S$1,500 at once at S$5.00, you get 300 units. If you spread the S$1,500 over three months at S$5.00, S$5.50 and S$6.00, you get about 274 units. At S$6.00 the lump sum is worth S$1,800 and the spread version about S$1,645.
The cost of investing all at once is emotional. Putting your money in the week before a fall feels terrible, and some people sell because of that regret. If spreading a lump sum over a few months is what gets you to invest at all and then hold on, that is a reasonable trade, as long as you understand that you are paying for comfort and still carry all the market risk.
Now look at where your own investing money will come from: your monthly salary, a lump sum you already have, or both. If you have a lump sum, decide now how you'll handle it, before a market headline decides for you.
Write down whether you will invest from your monthly salary, a lump sum, or both, and what you will do with any lump sum.
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