It is a sad fact that many people end up losing money in the stock market. Even market veterans who have been around for 10, 20 even 30 years could still be facing big losses. What are the causes of their failures? There are many reasons which contribute to this. For those who want to be successful, the only time tested method is the dollar cost averaging stocks method.
The Dollar Cost Averaging Stocks Method Explained
The dollar cost averaging method involves putting a fixed sum of money into the stock market slowly over a period of time. What the method does is to reduce the risk associated with market timing. Having to time the market is one major factor causing investors to lose in the stock market so with the dollar cost averaging method you tend to avoid having to make the crucial decision to time the purchases of stocks in the market.
Let’s say you have RM30K to invest and decide to pick a good stock named stock X priced at RM3 in the stock market now. Since the stock market is close to the all-time high, you are afraid of investing everything at one go of the share at RM3, so you look to lower your risk by spreading the purchase over some time, possibly purchasing 1,000 shares every month until the RM30K have been used up.
If the stock drop over the period, you could find that you actually reduce your cost of purchase of the stock. However, if the stock goes up instead, you will incur a higher purchasing cost of the stock.
Table below summarize the purchase of 1,000 shares over 10 months with capital of RM30K (and assuming the stock price mostly drop leading to lower cost of purchase) -
Month Purchase Price
1 3.00
2 2.99
3 2.95
4 3.00
5 3.01
6 3.03
7 2.98
8 2.92
9 2.93
10 2.96
Average cost = 2.977
Investors using the dollar cost averaging stocks method like this strategy because it is simple to understand and do not require special skills or high IQ – the method is a no-brainer as it just need someone to purchase a stock using a fixed sum of money at a fixed date until he is satisfied he has invested enough of the stock.
A recent variation of the dollar cost averaging stocks method require the investor to increase the number of shares bought if the share price drop or reduce the number of shares purchased if the stock goes up. It is called value averaging stocks method and is slightly more complex than the classical strategy but whichever the method used, the goal remains the same, which is to reduce the need to market timing and slowly invest into a stock over time.
Conclusion
Let’s say you have RM30K to invest and decide to pick a good stock named stock X priced at RM3 in the stock market now. Since the stock market is close to the all-time high, you are afraid of investing everything at one go of the share at RM3, so you look to lower your risk by spreading the purchase over some time, possibly purchasing 1,000 shares every month until the RM30K have been used up.
If the stock drop over the period, you could find that you actually reduce your cost of purchase of the stock. However, if the stock goes up instead, you will incur a higher purchasing cost of the stock.
Table below summarize the purchase of 1,000 shares over 10 months with capital of RM30K (and assuming the stock price mostly drop leading to lower cost of purchase) -
Month Purchase Price
1 3.00
2 2.99
3 2.95
4 3.00
5 3.01
6 3.03
7 2.98
8 2.92
9 2.93
10 2.96
Average cost = 2.977
Investors using the dollar cost averaging stocks method like this strategy because it is simple to understand and do not require special skills or high IQ – the method is a no-brainer as it just need someone to purchase a stock using a fixed sum of money at a fixed date until he is satisfied he has invested enough of the stock.
A recent variation of the dollar cost averaging stocks method require the investor to increase the number of shares bought if the share price drop or reduce the number of shares purchased if the stock goes up. It is called value averaging stocks method and is slightly more complex than the classical strategy but whichever the method used, the goal remains the same, which is to reduce the need to market timing and slowly invest into a stock over time.
Conclusion
The dollar cost averaging stocks method is a proven investing strategy practiced by institutional investors and veteran individual investors alike. The method reduces the risk of timing the stock market by slowly investing at a regular basis over a period of time. It is a perfect method for risk-adverse and the investor who like to invest stocks for the long term.
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