Dollar-cost averaging for phased investment a good option

It sounds easy, but in execution investors face the daunting task of determining the right time to buy stocks at the bottom and them sell them at the peak. Often, such an investor ends up doing nothing.

Dollar-cost averaging (DCA) may be the answer. This is a practice in which an investor puts a set amount of money into investments at regular intervals, usually monthly or quarterly. It is generally used for more volatile investments like stocks or mutual funds than for bonds or CDs and is a good wealth-building strategy for passive investors who are risk averse. If an investor has a lump sum of money to invest and puts it into the market all at once, he runs the risk of buying at the peak, which can be unsettling if prices fall after that.

The DCA method involves investing the money in smaller amounts over regular intervals, thus reducing the effects of any single market movement, spreading the risks out over time.

For example, an investor wants to invest in an index fund. He has a total investment of Bt20,000. By using DCA, he can invest Bt5,000 each quarter. The investor will incur an average cost of Bt33.4218 a unit for 598.41 units. The gain, compared with the average cost at the present net asset value, is Bt4,111.59.

If the investor invests the same amount in one go by using the "lump sum" concept, the risks are indeed higher. There is only a 50-per-cent chance that lump-sum investments perform better than using the DCA method, which may not look good enough to the average investor.

Similar to other risk-reduction strategies, DCA does have its drawbacks. First, there is a chance investors may miss out on a really good market move.

Second, it may be mentally tougher to buy when the market is down. But with DCA, a disciplined investor can overcome such fears and buy as stocks fall, which often provides an opportunity to buy shares at a discount.

DCA may not be the best choice for everyone. But it should work well for long-term investments in which day-to-day fluctuations matter little to the fortunes of a stock over the years.

Ratanachon Thanyodom is senior vice president for product management and business strategy in HSBC's Personal Financial Services Department in Thailand.