Posted on 06 Oct 2019
Doesn’t sound right to me though - if you start DCA at the peak, it could go on for a few months to years and given speculation on a recession in the next few months etc, does opportunity cost of not being in the market now really outweigh the pros of waiting for prices to appear much lower before going in? Or no difference?
Hi anon, to put things in perspective here, we need to consider a few things:
Do you know when the market peak is? Fact is, no one does. However, if you stay out of the market because you think it is at the peak and you are waiting for the bottom, it is very likely that you will continue to stay out because of fear that the time is 'not right'.
DCA will work best when you have a long enough time frame. There is a Straits Times article behind a paywall, but I will link you to the chart here (which is based on back-tested info): https://www.straitstimes.com/sites/default/files/attachments/2018/04/15/st_20180415_bizltdca15a_3909132.pdf What do you notice? We are looking at a timeframe of years on all the charts. Even in a U-shaped market, it takes 5 years for the market to return to where it was prior to the crisis. During the period where the market was headed south, it takes considerable nerve to enter the market, as your psychological frame of mind will likely be in a state of fear that it can go lower (if you aren't in that state of fear, then that's good for you, but it is not a common thing for most people looking to invest)
But if you DCA, you will just go in the market without looking at the timing, and just hold your investments through the market cycle.
Let's examine DCA at the peak (top chart), entering at the peak over 2 years via DCA leads to a smaller loss compared to going in at the start with a lump sum (e.g. if you entered at the wrong timing). Consider this as averaging down.
On the 2nd chart, assuming you entered at the start of the graph thinking that prices were at a low already, you would only recover to your initial capital after 5 years. But with DCA, you would be in profit already.
On the 3rd chart, entering at the start of the graph thinking that it was the low, then you would be right and rake in a substantial profit over time. However, DCA doesn't do too badly either, turning a profit over the same time frame.
(Edit: I just want to point out that if you have 100K right away, and you are certain the market will be in a bull run, then definitely don't DCA. Just go all in. But the fact is, how many of us have 100K just like that? We are more likely to invest out of our cash flow, which is to say we will have 100K to invest, but that is over 100 months at 1K/mth as we work and earn and set aside money.)
I personally have seen the effects of DCA on my own UT investments, with the U-shaped market from Feb 2018 till May 2019. Through this period, I continued to DCA into a balanced APAC Ex-Japan fund and was having a capital loss till the market turned around this year, after which I turned a profit even though the APAC market hasn't exactly returned to the peak in Feb 2018.
I hope that has given you some insights and perspective. Naturally, I also have a warchest that will be deployed when markets are down more than usual. I am of course incurring opportunity cost not investing my warchest, so I am keeping it in high interest savings accounts to mitigate my cost.
06 Oct 2019
Hi Elijah, thanks, those are some really helpful insights! One more thing - if an investor’s market sentiment is negative for the coming months, but is looking to do DCA now, would it be wise to DCA but at lower amounts now and when investor is more confident in the market then DCA at higher amounts, or would you recommend to just stick with the same level of investment amount throughout?
06 Oct 2019
Hi, yes, that is one possible strategy, to increase the DCA as market goes down. Or, you can just do lump sum deployments as well when market has fallen enough, provided that you continue DCA throughout the market drop. There's no right or wrong, just what you feel is comfortable for you.
Elijah gave a wonderful answer but I just want to emphasise on one thing.
The reason why we subscribe to DCA is purely because we don't know how the market behaves. We just can't truly predict it.
We don't know if it is currently at its peak or at its rock bottom. We don't know if it'll continue going up over the next 2 to 3 years, or go down during the same period.
However, it is still good to buy more when markets are on sale. So it shouldn't be DCA or Lumpsum, but a bit of both. You should set up a regular amount that you're comfortable with investing every month, but keep some money on the side for additional top-ups and markets look good to enter.
This way you don't miss out on any best days, and still, get to earn from market rebounds. There have been studies that show that if you miss out on just a dozen of the best trading days of the year, you would less than half of the year's total return. So staying invested allows us to not miss out on these peak days.
And the great thing about DCA is that when markets are either up or down, it is still good. You buy more when markets are down and when markets go up, well you're happy because your existing investment is doing well.
However, there's one investment where DCA may not make too much sense. And that is for non-volatile assets. It doesn't make too much sense to split a 10k investment into 1k over 10 months just to purposely 'DCA' especially if each investment has a purchase/trading cost.
At the end of the day, what matters most is the performance of the underlying stock/stock index you ...
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