Why Dollar-Cost Averaging is overrated

Happy businessman or manager brags success graph.

Dollar-Cost Average (DCA) is a very popular investing technique and I believe it is probably one of the first few techniques that new investors will come across. With so many books and articles explaining the benefits of DCA, I also think that it is well suited for a lazy investor like me – put in a fix amount every month and let father time do its magic. The returns may not be fantastic but I should be able to earn a decent 4 to 5%. Happy businessman or manager brags success graph.

I had the opportunity to take part in ST Engineering (STE) share ownership scheme and put in a fix sum every month.  I have been doing this since Sep 2012 and I increased my monthly contribution by a few dollars every year.

STE DCA

As of Dec 2016, my XIRR is -0.05%. How is that possible?

STE is suppose to be a ‘safe’ stock with little volatility and it never cross my mind that I will lose money. If I take away the dividends, I will lose even more. I recheck my calculation and it seems correct.

Perhaps I can find some clues from the stock price.

STE Price - Sep 2012 to Dec 2016
STE Stock Price – Sep 2012 to Dec 2016

At first glance, the chart looks pretty normal but as I digest it slowly, I realised that I started DCA when STE price is reaching historical high. I have been accumulating  STE at over $4 for about a year and the price dropped steadily after that. Although the price rebounded a little in 2016, the ‘damage’ has been done.

Some may argue that 5 years is too short for DCA to work but I beg to differ. If for the next 5 years, STE price remain stagnant (a high probability) or sinks further, I am pretty sure my XIRR will remain negative. Even if STE price starts to move up, it will probably be just to compensate for the first few years ‘lost’ due to the high price when I first started DCA.

My biggest take away is that market timing is very important. Don’t believe in ‘experts’ that tell you that since you are investing for the long term, you can start DCA anytime. I know that some of our local banks and financial institutions allow investors to buy a fix amount of blue chip stocks every month. In case you are wondering if blue chips will increase your ‘odds’, you can read about my post on STI ETF.

With that I leave you with this definition of DCA by Investopedia:

Dollar-cost averaging (DCA) is an investment technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. The investor purchases more shares when prices are low and fewer shares when prices are high. The premise is that DCA lowers the average share cost over time, increasing the opportunity to profit. The DCA technique does not guarantee that an investor won’t lose money on investments. Rather, it is meant to allow investment over time instead of investment as a lump sum.

Source: http://www.investopedia.com/terms/d/dollarcostaveraging.asp

Comments

  1. ironsight says

    you didn’t include cost of commission, if you’re buying $300 worth of stock per month, fees will take up 8% of your returns. problem is not the strategy, it’s commissions.

  2. STE says

    Hi Derek,
    Yah ! You are absolutely right ! ” time and timing ” are equally important ,,, good timing or entering price is crucial to ensure higher return and having ” margin of safety ” during market downturn,,, especially blue chips,,,once analyst start to recommend on particular stock,,, seems everyone start to rush in and buy ,,, forget about the valuation ,,,,hence pushing up the price ,,,,
    BTW,,, investing in me ( STE ) might b better that your STE ,,, hahaha :-) just kidding,,,
    Cheers !!

  3. says

    Just wondering whether DCA works better with ETFs rather than individual stocks. I would think the investment time horizon makes a difference but I’m testing this out for myself as well!

  4. Gabriel says

    well, i guess the problem with using DCA on a single stock is that you have to be very sure the company will stand the test of time.

    The advantage though of using DCA on a broad market index such as a global index or just STI ETF is that it takes away some risk of a single company going down and bringing you down as well.

    • says

      Hi Gabriel,

      You are right that DCA is more suited for a basket of stocks like an Index to prevent the risk a single company going down. However, I believe the people who come up with this technique wasn’t looking at an index but individual stocks. At the end of the day, the timing and the stock we buy are equally important.

  5. says

    Hi Derek, first of all, I enjoyed reading thefinance.sg very much. Great site.

    From your blog on DCA on STE, I gather you are an employee of STE who subscribes to their share ownership benefit. I was with STE before. I believe you will continue with this subscription due to the additional benefits which you didn’t disclose in this blog. I am not sure if this has changed, but I was once “forced” to sell all units (shares) by STE (HR policy) due to promotion to another grade. And that happen in 2008, at the height of financial crisis.

    Just a note here in case you weren’t aware. Thing might have changed. Best to check with your HR.

    • says

      Hi CK,

      Thanks for your kind words and advice.

      Yep, I am an employee and I have just added that I took part in the share ownership scheme in my article. To sell at the height of the crisis sucks. I am aware of these rules and I am looking to off load a portion of it when the opportunity comes.

  6. says

    Not sure when I grow older will i still be able to fill the math box to post comment hahaha
    I did once many years ago in a large american stock. It works provided the stock come back up. And the dividends will work it’s magic into the gains. So I would say apply to company that needs to meet specific criteria.

    For your case because the stock is still dangling low, it should not mathematically. :)

    • says

      Hi Cory,

      Its simple maths. I’m pretty sure you are used to dealing with something more complex ;)

      I’m thinking the price swings of American stocks is more wide? Hence, DCA is actually more effective?

      • says

        I don’t have the data. Gut feel I think American Companies survive very long in the market. Maybe because they are MNCs. Their innovation allows the companies to come back. Ofcourse there is exception where the company disappear like Enron. So we still have to pick stock and not roll of dice unless we are doing Index type. And DJIA index did very well if we do DCA.

  7. says

    Hi Derrick,

    I feel that DCA is just an acronym banks throw at people to make it seem like their product can “cheat” and perform better in a volatile and sideways market.

    DCA is an accumulation method, and it’s a simple one. Value Averaging is another accumulation method and I find it far superior to DCA is every single aspect, except ease of implementation and follow up execution.

    Though inferior in returns, DCA does have a behavioral benefit – it forces people to be invested, regardless of the market conditions. The problem of many beginners is decision paralysis and the inability to actually stick their first $1 into the market. DCA helps eases beginners into the market and gets them invested instead of perpetually waiting on the sidelines while researching market timing strategies.

  8. ccloh says

    need to see the detail of your share ownership scheme.

    as far as i’m concerned singapore stock market is not optimized for DCA. first you have the commission factor (in your case you do not have). second it is the min board lot size issue. in the past min board lot is 1000 share but now reduce to 100 share but under DCA you need min board lot to be 1 share. DCA is every month you put in the same amount of cash and depend on the price, the quantity will be difference. as such, when price is lower, you will have more share to average down those you bought at higher price. for singapore market since we can’t do min board lot of 1 share and from the table you provide, the cash put in is changing and not constant so i assume your DCA is every month get the min board lot as such, you do not have quantity at lower price to negate or average those at the higher price.

  9. says

    Hi Derek,

    Dollar cost averaging into a single stock is dangerous. Do it for a diversified portfolio like an international equities fund. After all, dollar cost averaging is a tactic, not a strategy. Our strategy should be to identify a stock that will always rise no matter what. Dollar cost averaging is simply a tactic to lower the cost of investing.

  10. InvestWizar says

    1. You are making a systematic bet on one company (i,e, STE), which goes against the usual practice of diversifying your risk across a wide variety of stocks. The lazy investor approach is not only about time diversification, but also on stock/asset class diversification.

    2. The 2012-2016 period happens to be a very poor performing period for the manufacturing sector. By concentrating your bet on STE, it is not surprising that you yield less than desirable returns. This is what happens when you adopt a lazy investor approach of not doing proper research and did not diversify your position,

    3. Everybody knows market timing is important, but the fact is investors who can time the market are extremely rare. The reason why ppl do DCA is because most of us are not good at timing the market. I dont it is appropriate to compare the investment return retrospectively and conclude that DCA is inferior. What if you invested a lump sum at the wrong timing? In that case, the XIRR would probably be much more negative than -0.05%

  11. says

    Hi. This is a very interesting topic. Rules like this can easily tested on historical data. Before applying such a “strategy” I would test it. Since I have tested thousand of “general rules” I can say it is not as easy as it seems. Not even if you apply it on an index ETF. Unfortunately I can not upload screenshots here, it seems, otherwise I would show some examples. Please let me know if you are interested.

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