How to Optimise Dollar-cost Averaging to 2X Your Investment Return
How to Optimise Dollar-cost Averaging to 2X Your Investment Return
Dollar-cost averaging is a strategy in which an investor places a fixed dollar amount into a certain given investments on a regular basis.
The investment generally takes place every month regardless of what is occurring in the financial markets. So if their market falls, the same fixed dollar amount can afford to buy more quantity. Contrarily, less quantity is bought when the market rises.
This is a great mechanism that is designed to take the emotion factor out from the investment equation. It regulates us to invest a fixed amount despite the performance of the market. We buy more when the market is low with the fixed amount and we buy less when the market is high — this is the way we all should and want to invest but we fail to do it on our own. It is an automated investment system.
The reasons we want to optimize it are:
We want better investment returns.
There is a built-in downside of dollar-cost averaging that following the plan, we need to buy and invest the same amount even when the prices are high or ridiculously high. Beware that this “prices getting too high” comments can be subjective. So if we are going to enhance and optimise it, we need an add-on system that does not require us to think and hence continue to detach emotion from our investment system.
Extended reading: Why Dollar-cost Averaging investment Gives Better Return than Lump Sum investment (Plus its Pitfalls and Solution)
Cash reserve
We have mentioned the importance of building a cash reserve, regardless of whether we are anticipating any crisis on the horizon or not. Cash is king and we never know what it is needed — to serve as buffer and adds to the bottom-line, or to the opportunity to invest at a discounted price when the market is driven by fear.
One of the ways we can build a cash reserve without having to set aside another patch of money is by optimising the dollar-cost averaging. When the prices get ridiculously high as shown by our add-on system, we can set aside 1/3 or even 1/2 of the fixed amount we dedicate to invest every month under our dollar-cost averaging scheme. This way, the 1/3 or 1/2 of a fixed amount would become our cash reserve that could come in handy.
Extended reading: How much Cash should you reserve?
Take the opportunity of volatility
Volatility is the nature of the stock market. It goes up and down, further up and further down every hour, every day Monday to Friday, because people are getting in and out, institutions are getting in and out. With the dollar-cost averaging mechanism, we robotically invest in stocks in the proportion that we have set, regardless of price (as that is adjusted through the quantity that we can afford), economic situation, and volatility.
In fact, we can make volatility works for us if we have a simple add-on to the dollar-cost averaging because now when we purchase, we have reference to where the stocks/bonds / ETFs / other financial tool is within its historic or usual range of motion. Volatility becomes our friend.
How to optimise
Take Google stock as an example.
Step 1:
We can see that its historic range of volatility is roughly between 0 to 1,500. We divide this into 3 parts.
Eg. .With Google’s stocks, we can slice them into:
$0–500
$500–1,000
$1,000–1,500
Step 2:
Now we have 3 regions of where the Google stock could be and we have a better idea of how expensive it is with reference to its historic prices.
E,g, if it is now priced at $1,100, we know it is near the bottom of the range of $1,000 — $1,500. So we continue our fixed investment under the dollar-cost averaging.
E.g. 2 if it is at $1,500 now, then we know it is at the top of the range, we can put aside 1/3 or 1/2 of our fixed amount as cash reserve (to be invested when this stock’s price becomes more reasonable in the range of motion).
Note: you do not have to use the full historic price change for this optimisation. I have used 5 years, or 6 months for my own optimisation. The time frame depends on the stocks you are looking at and how volatile it is. Yet, the principle remains the same and is applicable for all stocks.
Note: the cash reserve should stay in our investment account so that we would not spend it. It is still dedicated to the relevant stock but we are just waiting for a more reasonable price for purchase.
With this simple 2-step add-on, we can have a reference point of whether the price is reasonable or not with reference to its range of motion within a certain time period.
The result:
If you invest with dollar-cost averaging in a stock vs invest with dollar-cost averaging plus add-on, the latter resulted in 2 times or more return. Say if you can have 5% return with dollar-cost averaging, this optimisation can give you 10%!
It is very easy to implement and requires no calculation at all! Give it a try!
Note: this is not investment advice. I’m not financial planning professional. Just sharing what is working for me as part of my investing strategy or what I have learned on my investment journey. Please be reminded to do your own research and consider your own circumstances before making any financial decisions. You could also check with your financial professional to understand what would be best for your situation.
