Dollar cost averaging or lump sum investing?

Dollar cost averaging or lump sum investing?

By Daniel Buenas - Jan 29, 2007
The Business Times

A CONCEPT, or practice, that is often touted by financial advisers and those in the financial community is that of dollar cost averaging.

This means investing a fixed sum of money at a regular interval, regardless of how the market is doing.

However, while it is a commonly-used technique, not everyone feels that dollar cost averaging is a good practice. Some critics even claim that it is more of a marketing ploy, rather than a risk-reducing strategy.

So should an investor consider dollar cost averaging, or is one-time lump sum investing better? Before we examine that question, we'll relook at an example we've mentioned before on this page to better understand the concept.

Some retail investors try to 'time' their investments. If they are lucky, they may gain more, but could also lose more if they buy when prices peaked. Imagine if you wanted to invest $1,000 in company ABC whose stock is currently selling at $10.

SCENARIO 1: No Dollar Cost Averaging

If we bought it as it is, we get 100 shares of ABC with our $1,000. Assume 10 months have passed, and we decided to sell our ABC shares which have fallen to $5 a share. At that price, our shares would be worth a total of $500. Or we make a $500 loss.

SCENARIO 2: Using Dollar Cost Averaging

Now we assume we start out with the same $1,000, but this time we spend $100 at the start of every month for 10 months to purchase ABC shares.

The share price remains steady at $10 for the first five months, which means we purchase 10 shares a month for five months, or 50 shares.

For the next five months, the share price drops to $5 a share, which means we now purchase 20 shares a month for five months, or 100 shares.

At the end of the 10 months, we have accumulated 150 shares currently worth $5 each. If we sold them all, we would get $750. Or the loss is $250, compared to a $500 loss in our earlier example.

This illustration is simplistic, but it does demonstrate the basic principle of dollar cost averaging.

But some market watchers believe that dollar cost averaging may not be as effective an investment technique as some purport.

For example MSN Money Insight contributor Timothy Middleton says in a column on the MSN Money website: 'Dollar-cost averaging is easy to sell to nervous investors because calamities do happen in financial markets, and they can seldom be foreseen.'

However, Mr Middleton says calamities are 'astonishingly rare'.

'When the market is studied over long periods, dollar-cost averaging almost always produces lower returns than investing lump sums in diversified portfolios, and almost never reduces risk meaningfully,' he says, adding that investors should 'invest on any schedule you wish, (as) they all work out in the end'.

Salman Haider, Citibank Singapore's head of investments, points out that regular investing tends to perform better than lump sum investing when markets are volatile but trending upward.

As an illustration, he cites the three ways investors could have invested in global equities over the last 10 years.

'As you can see from the chart over the past 10 years, lump investing actually outperformed dollar cost averaging because of the strength of the global equities market,' says Mr Haider. 'However, not everyone has the money to put in a large sum at the outset, or the discipline to sit tight on their investments for a long period. Hence, a dollar cost averaging approach may be more realistic.'

So which should an investor choose?

'The answer really depends on your view of the market, your time horizon and objectives,' Mr Haider says. 'But generally speaking, if you are someone who does not want to worry about volatile markets, who wants to avoid letting their emotions get in the way, or to simply put some money aside for the future, then regular investing may be the option, as it allows you to build your wealth in a consistent and disciplined manner.'

However, he also points out that there are some benefits to dollar cost averaging, as regular investing does require discipline, which may be difficult, especially when markets are volatile.

'This is one reason why we encourage customers to sign up for a regular investing plan,' he says. 'With an automated process, you will keep to your plans and are less tempted to discontinue especially when markets are down. Such plans are also affordable; in most cases, you can invest with as little as S$1,000 initially, and $100 thereafter.'

A good option, he adds, would actually be to do both lump sum investing and dollar cost averaging by starting with a small lump sum and topping up with a regular savings plan.

'That way, you benefit from the best of both worlds,' he says. 'Investors should understand that investing is not about 'timing the market' but about 'time in the market'. So invest regularly, with a long-term view and stay disciplined in that approach.'

Dollar Cosr Averaging

Dollar cost averaging is a technique designed to reduce market risk through the systematic purchase of securities at predetermined intervals and set amounts. Many successful investors already practice without realizing it. If you participate in a regular savings plan, you are already using this tool. Many others could save themselves alot of time, effort and money by beginning such a plan. Dollar cost averaging can lower an investor's cost of investment and reduce his risk of investing at the top of a market cycle.

The beauty of dollar cost averaging is that you buy more shares when prices are low and fewer shares when prices are higher. The result is an average cost that is better than trying to time the market with your investments.

What is Dollar Cost Averaging

Instead of investing all his money at one go, the investor gradually builds up a position by purchasing smaller amounts over a period of time. This spreads the average cost over the period, therefore providing a buffer against market volatility.

In order to begin a dollar cost averaging plan, you must do three things:

1. Decide exactly how much money you can invest each month. To be effective, you should have sufficient funds to continue investing through the market cycle.
2. Select an investment (index funds are particularly appropriate) that you want to hold for the long term, preferably five to ten years or longer.
3. At regular intervals, weekly, monthly or quarterly, invest that money into the security chosen.

An example of a Dollar Cost Averaging Plan

Here's how it works. The principle is simple: Invest a fixed amount of money in the market at regular intervals, such as every month, regardless of whether the market is up or down.

Let's assume you have $12,000 and you want to invest in a stock. You have two options: you can invest the money as a lump sum now, walk away and forget about it, or you can set up a dollar cost averaging plan and ease your way into the stock.

You opt for the latter and decide to invest $1,000 each month for one year. Assume further that the stock started at $10 per unit and reaches $16 per unit a year later.

Had you invested your $12,000 at the beginning, you would have purchased 1,200 shares at $10 each. When the stock closed for the year in December at $16, your holdings would only be worth $19,200!

Had you dollar cost averaged into the stock over the year, however, you would own 1,643 shares as shown in Table 1; at the closing price, this gives your holdings a market value of $26,228.

Why Dollar Cost Averaging Works

The system works because it takes the emotion and temptation to time the market out of the process. You establish an amount that is comfortable for you to invest and let the market work for you. The system takes the decision-making elements of how much to invest and when to invest out of your hands. Dollar cost averaging solves this problem by eliminating the need to predict an entry point.

Chart 1 shows what happens when you invest $1,000 per month for twelve months in an investment that fluctuates in price. The average market price per unit is $8.08. Look at Table 1, your average cost per unit = $12,000/1,643 which is approximately $7.30. Thus, the example shows that you don't have to guess when to purchase shares to get a better price.

Will dollar cost averaging guarantee you a profit? No system can do that. However, if you buy quality investments and continue dollar cost averaging over a long period, you will have a much better chance of success than trying to get in and out of the market at the right times.

Buy Low, Sell High

For long-term investors, dollar cost averaging is a powerful tool that takes much of the emotion out of investing and lets the market work for you. One of the major problems facing individual and professional investors alike is determining when to buy a particular stock or, in other words, how to find the bottom of a price swing. The problem is that no one is consistently correct in calling this point on individual stocks and certainly not on the whole market. If you miss this point and the stock begins to move up, you have lost some of the potential gain by not buying at the right point. Very few people buy at the bottom. Those who do, typically happen to have been averaging all the way down.

Market timing is a dangerous game, especially when practiced by beginners, who typically tend to over expose themselves to the market. Market timing is an attempt to predict future price movements through use of various fundamental and technical analysis tools. The real benefit of knowing what is going to happen is that your return from buying a stock before it takes off is better than if you had bought the stock on its way up.

Market timers are the ultimate "buy low and sell high" traders. Day traders, who move in and out of positions in minutes or hours, are the extreme market timers. They look for small profits by the dozens each day by capitalizing on swings in a stock's price.Most market timers operate on a longer time-line, but may move in and out of a stock quickly if they perceive an opportunity.

There is some controversy about market timing. Many investors believe that over time you cannot successfully predict market movements. Market timing becomes more of a gamble in their opinion than a legitimate investing strategy.

Market Timers and the Next Big Thing

Some investors argue that it is possible to spot situations where the market has over or under valued a stock. They use a variety of tools to help them predict when a stock is ready to break out of a trading range. Usually, the market proves them wrong. Stock prices do not always move for the most logical or easily predictable of reasons.

An unexpected event can send a stock's price up or down and you cannot predict those movements with charts. The Internet stock bull market of the late 1990s was a good example of what happens when investors in the excitement of the moment, consciously or not, overpay for their investments. Those who bought then are not likely to have made much money.

Everyone has a hot tip about the next "big thing" and investors are always jumping on stocks as they shoot up. Unfortunately, most of these collapse just as quickly as many investors typically hold on way too long. The disastrous result is usually the exact opposite of what they were hoping for. In the end, it is usually a case of "buying high and selling low". For most investors, the safer path is sticking to investing in solid, well-researched companies that fit their requirements for growth, earnings, income, and so on.

In conclusion, dollar cost averaging takes the emotion out of decision-making and is a useful tool for the individual investor who wants to buy and hold a stock for the long term. Over time, it will usually result in a better entry price than timing when to buy.

If you look for undervalued stocks, you may find one that is poised for moving up sharply given the right circumstances. This is as close to market timing as most investors should get.

Contributed by Peter Heng, Chief Investment Officer, Manulife Singapore

Investors must keep at least $30,000 in Special Account

The Straits Times - Feb 14, 2009
budget debate: CHANGES IN CPF

Investors must keep at least $30,000 in Special Account

PEOPLE with less than $30,000 in their Special Accounts (SA) will not be able to use these funds to invest under the Central Provident Fund Investment Scheme (CPFIS) from May 1.

Acting Manpower Minister Gan Kim Yong said this was being done because the SA receives an additional interest on its funds, and also because of the uncertainty around CPFIS returns.

'Given the higher interest rate on the SA and the uncertainty of CPFIS scheme, it is better to be more conservative,' he said yesterday.

The change will not affect existing investments.

Currently, all CPF members earn a flat floor rate of 4 per cent on their Special, Medisave and Retirement Accounts (SMRA).

But by the end of this year, interest rates of the SMRA accounts will be floated and pegged to the average yield of 10-year Singapore Government Securities rates.

They will earn the floating rate plus 1 percentage point.

CPF members earn higher interest on their first $60,000 of savings - 5 per cent on their Special, Medisave and Retirement accounts, and 3.5 per cent on up to $20,000 of their Ordinary Account.

Previously, CPF members had to keep a minimum of $20,000 each in their Ordinary and Special accounts before they could start to invest.

But with this change, they will need to keep a minimum of $30,000 in their Special Account and $20,000 in their Ordinary Account.

The excess funds can be invested in CPF-approved bonds, equity-linked funds, unit trusts and investment- linked insurance products.

Latest data from the CPF Board showed that investments in such products have not been paying off.

In December last year, the CPF Board said nearly half of all CPFIS investors who sold their Ordinary Account investments last year lost money, up from 43 per cent in 2007.

Only about 174,000 members, or 20 per cent made profits from their CPF savings over and above the 2.5 per cent they could have earned anyway.

These figures reflected the financial meltdown that began in September last year, the CPF board said at the time.

It said that CPF members had withdrawn $7.8 billion from their Special Accounts for investments.

Nearly 80 per cent of that figure, or $6.19 billion, went into insurance policies. About $1.61 billion went into unit trusts.

AARON LOW

A beacon of stability

Business Times - 14 Feb 2009
A beacon of stability

With prices hitting new records, gold promises to become even more appealing as billions in US government stimulus set the stage for rising inflation and a weaker dollar

THE gold-mining sector is rapidly emerging as a beacon of stability in an uncertain stock market, and a flood of recent equity issues by miners has topped up their balance sheets and laid the groundwork for a new round of takeovers.

With gold well above US$900 an ounce, investors have shown strong appetite for a sector that promises to become even more appealing as billions in government stimulus set the stage for rising inflation and a weaker US dollar - conditions that typically trip a buy signal for the precious metal.

Canadian miners Kinross Gold, Agnico-Eagle Mines, and Yamana Gold have collectively raised about C$1 billion (S$1.2 billion) in the past two months, stocking up their war chests at a time when many companies are struggling for cash.

'This is a reflection of gold being pretty well the only game in town in light of the woeful economy,' said John Ing, president of investment dealer Maison Placements.

But it's not just the top producers that are finding the funding taps still open. Developer Osisko Mining , which is moving part of a town in western Quebec, Canada, to build the Malartic gold mine, announced a bought deal last week that could be worth up to C$400 million, defying the recent thinking that junior explorers are running on a treadmill to insolvency.

The trade-off for Osisko is that it had to sell the shares at a deep 17 per cent discount to its market price to drum up demand. But the money raised will fund its mine nearly to completion, at which point it will have steady cash flows to rely on.

Other smaller players bulking up include Minefinders Corp, which completed a C$40 million bought deal in December, and Africa-focused Red Back Mining, which announced a C$150 million bought deal in late January that the company plans to use to fund an aggressive M&A push.

The thirst for shares comes as most equity sectors are still struggling to rebound from last year's market plunge, while worries of corporate defaults and narrow government bond yields have kept investors wary of debt instruments.

'What we've been seeing since the beginning of January is there's a sea change that's taking place,' said Frank Holmes, chief executive of fund manager US Global Investors. 'All these pension fund groups are recommending gold. I think what's really significant here is a lot of these buyers are (typically) non-gold fund buyers.' The buying has propelled shares of many established gold producers up to levels not far off the record peaks hit last year when gold topped out above US$1,030 an ounce.

The Toronto Stock Exchange's S&P/TSX global gold index, which tracks gold producers listed on several exchanges, has more than doubled from its trough in October last year, compared with a flat performance or slight gains since then by major stock indexes.

However, valuations for smaller players have remained compressed, a scenario that yields a big opportunity for cash-rich large miners to add assets on the cheap.

'It is a time of unprecedented opportunity,' Kinross CEO Tye Burt said of the wide valuation gap between large and small miners. 'So we thought it prudent to top up.' With gold at these levels, analysts expect several more gold miners to come to the equity trough to load up on cash, and a small bump higher in gold prices could be enough to trigger deals.

'It happens when gold goes over 1,000 bucks (an ounce),' said Mr Holmes. 'As gold goes through US$1,000, you'll get a revaluation of that whole space.'

Gold has 'very strong support' at about US$600 an ounce as any drop below that level would result in the closure of 20 per cent of the world's production capacity, OAO Polyus Gold chief executive officer Evgeny Ivanov said.

A 60 per cent increase in mining costs in the last two years, because of rising oil, steel and machinery prices, pushed the cash cost of producing gold in Australia to US$635 an ounce, Mr Ivanov told an Adam Smith conference in Moscow on Thursday.

'Below US$600 an ounce, mining in South Africa and Australia becomes unprofitable,' Mr Ivanov said. The nations are the world's second and fourth-largest producers of the precious metal, according to the US Geological Survey.

Polyus, Russia's biggest gold producer, has planned its budget for this year based on an average price of US$800 an ounce. OAO Polymetal's figure is US$750, CEO Vitaly Nesis said at the same forum.

Gold has averaged US$790 an ounce in London in the last two years, falling as low as US$606 in January 2007. It last traded below US$600 in October 2006. -- Reuters, Bloomberg

NTUC Income bucks trend with 14% growth

The Straits Times - Feb 14, 2009

NTUC Income bucks trend with 14% growth

By Lorna Tan

INSURER NTUC Income has bucked the current slowdown by notching up strong 14 per cent growth in its life insurance premiums (excluding annuities) to $255.8 million last year.

This was a far stronger performance than overall industry growth in the same period of a mere 3 per cent.

Income posted strong figures during the second half even as the turmoil from the global financial crisis rocked markets and left many insurers struggling.

The firm said it had emerged as a market leader during the six-month period as its life insurance sales jumped 30 per cent to $149.2 million, compared to an overall industry contraction of 18 per cent.

That was in contrast to a 2 per cent contraction in its life premiums in the first half of last year.

During the same period, the insurer also emerged as the market leader in the annuities segment, accounting for more than half of the overall sales.

Income's strong second-half performance was strongly supported by solid growth in the final three months of last year - just as the financial crisis was reaching a grim crescendo.

In fact, Income said it was the only insurer here during that turbulent period which posted a positive sales growth - of 8 per cent, compared with the same period a year earlier. This was in stark contrast to the 42 per cent contraction registered by the industry.

The figures are based on a weighted premium measure which takes into account just 10 per cent of a single premium and all of a year's premiums for regular premium plans.

Income chief executive Tan Suee Chieh attributed last year's strong performance to its multi-channel distribution strategy, ongoing focus on its people and its reputation as a trusted Singapore company.

'We engaged independent financial advisers and re-established our ties with corporate agents selling motor insurance. This, and probably some luck, is an important reason for our sales success.'

Besides its 600 full-time and 900 part-time agents, Income's products are available through its branches, brokers, corporate agents and the Internet.

When Mr Tan took over the helm in February 2007, he had a vision of making the firm Singapore's top insurer by this year. He also wanted to reclaim its No. 1 position in the motor insurance business here, a spot it last held in 2004.

Last year, Income's motor insurance business grew 37 per cent to $237 million, compared to an industry projected growth rate of 19 per cent. This worked out to a market share of 26.5 per cent.

Looking ahead, he said: 'I'm happy if we remain in positive territory this year because of the tougher environment.'

In view of the gloomy economic climate, Income said it would cut costs to save jobs in the short term, instead of vice versa. It also expects to invest in the areas of customer service, sales and information technology.

Rules on CPF top-ups for family members eased

The Straits Times - Feb 14, 2009
budget debate: CHANGES IN CPF
Rules on CPF top-ups for family members eased

MORE CPF members will be able to top up the accounts of their family members following changes announced yesterday.

From April, they need only to have CPF balances of at least the prevailing Minimum Sum before being allowed to do top-ups.

At present, they need to have 1.5 times the Minimum Sum in their account before they can top up someone else's account.

Age restrictions will also be removed from August.

Currently, top-ups to parents and grandparents can be made only to those aged 55 or above.

The changes announced in Parliament are aimed at encouraging individuals to help older family members build up their retirement savings, Acting Manpower Minister Gan Kim Yong (below) said.

The rules for the top-up have been progressively eased in recent years, such as the change last year making it easier for CPF members to receive top-ups to their Retirement or Special accounts.

Such top-ups, said Mr Gan, can help older CPF members participate in CPF Life - the annuity scheme which provides a steady stream of income for life.

Those who turn 55 in 2013 will automatically go on the scheme, if they have a minimum of $40,000 in their CPF accounts.

The top-ups, Mr Gan added, will also help CPF members enjoy the 1 per cent extra interest on the first $60,000 of CPF savings.

'Naturally, if CPF members continue to work after 55, this would be the best way for them to continue building up their balances to participate in CPF Life,' he said.

SUE-ANN CHIA

Higher Medisave limits will lower out-of-pocket expenses

The Straits Times - Feb 14, 2009
Higher Medisave limits will lower out-of-pocket expenses
By Judith Tan

WHEN Emilia Dayana Abdul Hamid needed an operation on her knee in December last year, she opted for the semi-private B1 class at Alexandra Hospital (AH) for her hospital stay.

'I thought I was covered by the company's managed health-care scheme (MHS),' said the 25-year-old customer service executive.

She was not. Instead, she had to pay the bill herself.

Her Medisave account took care of $1,932.59 of the total bill of $3,121.81. The remaining $1,189.22, or 38 per cent, had to come out of her own pocket.

Someone in Ms Emilia's shoes this June is likely to be more fortunate. That's when new, higher limits kick in as to how much can be taken from one's health savings account, Medisave, to pay for hospital bills.

Ms Emilia would have paid just $222 out of her own pocket - only 7 per cent of her total bill. She would have saved more than $960.

Saving such out-of-pocket spending was one of the goals of the Health Ministry's (MOH) budget this year, which is swelling by nearly $1billion to $3.7billion as it anticipates patients needing more help with medical bills.

By June, Medisave withdrawal limits of $150 to $5,000 for operations will be raised to $250 to $7,550, reducing 'out-of-pocket expenses of all surgical patients, particularly those in Classes A and B1 and private hospitals', Health Minister Khaw Boon Wan told Parliament on Monday.

He was replying to Madam Halimah Yacob (Jurong GRC), who had asked for the use of Medisave to be expanded, to help cash-strapped Singaporeans.

This is the second time in two years that Medisave limits have been raised.

In 2007, the withdrawal limits for daily hospitalisation charges were raised to $450.

Both measures are aimed at helping middle-income Singaporeans who opt for private A and B1 wards in public hospitals, or the services of private hospitals.

The changes in June are unlikely to affect subsidised patients in B2 and C class wards, since the current limits are enough to cover their share of the bill.

The most common surgery performed in Singapore is colonoscopy with the removal of polyps or growths. The procedure costs between $900 and $2,000.

This is followed closely by coronary angioplasty, a procedure to enlarge the narrowing blood vessels that supply blood to the heart. It costs about $16,000 to $20,000.