The Regular Savings Plan (RSP)
utilizes the dollar cost averaging (DCA) concept of investing which is
the practice of investing a fixed amount of money regularly regardless
of market conditions. In the case of RSP, the investments take place
monthly. This article helps investor understand the benefits of DCA and
what considerations that an investor has to make in executing a dollar
cost averaging plan.
Benefits of Dollar Cost Averaging
For many investors, market timing of
buying low and selling high is almost an impossible task especially when
fear and greed typically lead investors to do the opposite of buying
high and selling low. The main benefit of DCA is that it takes the
guesswork and emotion out of investing.
By investing a fixed amount on a
monthly basis, RSP ensures that you accumulate more units when prices
are low but lesser when prices of units are high. A lot of stress is
avoided as the investor does not have to decide whether the fund is
expensive or not and whether the market condition is suitable to invest.
Table 1 shows a hypothetical example of how more units are acquired
when prices are low and vice versa assuming that an investor invests
$100 every month. Chart 1 is the graphical presentation.
Table 1
Investment amount ($)
|
*Price ($)
|
Units Acquired
|
|
January
|
100
|
1.00
|
100.00
|
February
|
100
|
1.14
|
87.72
|
March
|
100
|
0.90
|
111.11
|
April
|
100
|
1.03
|
97.09
|
May
|
100
|
0.95
|
105.26
|
June
|
100
|
0.89
|
112.36
|
July
|
100
|
1.08
|
92.59
|
August
|
100
|
1.19
|
84.03
|
September
|
100
|
0.85
|
117.65
|
October
|
100
|
0.98
|
102.04
|
November
|
100
|
1.17
|
85.47
|
December
|
100
|
0.83
|
120.48
|
* Prices are randomly generated
Source: iFAST Compilations
Chart 1
Many investors procrastinate in
investing, preferring to accumulate a large sum of money before deciding
where to invest. The temptation of spending the sum meant for
investments could also derail longer-term financial goals. By deducting a
fixed sum of money from the bank account and placing them into funds,
RSP also instills discipline in investing.
This helps investors steadily
move towards their financial goals. Moreover, with investors now
starting young, many may not have the luxury of investing a large lump
sum. RSP becomes a practical method of "invest-as-you-earn".
Lump sum investing would be better for investors with long investment horizon
DCA is a strategy that works well in a
market environment that is volatile, experiencing both upswings and
downswings but ends at a level that is close to the initial level.
However, historical data shows that most stock markets do exhibit an
uptrend over the long term.
This means that for investors who have a
large sum of money to start their investments with and coupled with a
long term investment horizon, they would be better off investing the
money right away (refer to " Long-Term Investing Works").
Although lump sum investing works
better than DCA assuming that stock markets continue their long-term
uptrend, investors are often paralyzed with fear in times of heightened
volatility such that they put off investing. These investors can
consider DCA in such times to start their investments.
By breaking the
lump sum into smaller parts, investors can view it as a chance to
average down their costs when markets move down. On the other hand, if
the markets move up subsequently, investors would have already invested
part of their money.
The main benefit of DCA in times of heightened
volatility is that it helps investors overcome the fear of investing in
turbulent markets.
Now that we have explained the
benefits of DCA, the following steps would help the investor execute the
method of DCA through RSP.
Actions to take for RSP
- Decide on the monthly amount that can be sustainable over the investment horizon
- Select the funds to invest into, making sure that portfolio is diversified.
- Rebalance your funds at least annually to ensure that your portfolio remains diversified
- Wait for your investments to reap rewards.
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