The benefits of average dollar cost vs lump sum investment.

by Yin on January 27, 2010

in Finance or Money,Income

Suppose $10,000 is all you are able to set aside to invest. Since no one could predict the market, avoid putting in the entire sum. Put in an initial amount, say $2000 to invest, then do dollar averaging to deduct maybe $100 or $200 per month for you to purchase the funds.

Average dollar costing is a proven strategy that enables a person to  make money in the long run- regardless of rising and or falling markets. All you need is staying power- 5 years and above. 

Let me share my humble experience with you. In 2007, I did a lump sum investment when the market was going up. Within one month, I made back the service charge- the market was so good. A month later, I dumped in another lump sum.  Then shortly after, the market crashed and I lost money in the fund. Till today, 2010, I still lose about 12% from my total investment. 

On the other hand, another person also bought funds in 2007 during the market peak and did dollar averaging (deduct a fixed amount from his bank account every month to buy the fund in small amount). And today, he actually managed to make money from the fund.

Unless a person could accurately time the market to go in when unit price are at their lowest- only then will the person benefit by doing lump sum investment. But looking to the fact that even experts cannot time the market, so what’s more to say about us, the small little fries. It would be safer to go by the average dollar route- then price movement would tend not affect us negatively if we have staying power.

Forced Savings- better than waste money away

Take some time to think seriously on how much you can set aside every month- money that you’re going to put to waste anyway if they lie around in your banking account. Don’t tell me that your expenses are tight- and that you have no extra money to invest. Surely there are some expenses like cutting down on memberships that you do not use, buying slightly less clothes or expensive items- total them up and you will be amazed that you do have some money after all (even with my pay cut, I am still able to save if I am willing to forgo some expenses).

And invest the money. Don’t let it stay idle in your account- set up an autodebit to transfer the money out to investment every month. You will be amazed at the result.

Let me share with you another of my personal experience to let you see how a little forced savings goes a long way:

About 10 years ago, I bought an investment linked policy for myself. The agent asked me what my goal was- I told her I wanted the policy to act as savings and to recover as much money as I can when the policy matures. She mentioned policy tied with unit trust (investment linked policies were very new in the market then). I was totally allergic to the word ‘unit trust’ as I had perceived it to be risky and may cause us to lose money. The agent tried to talk to me about it but I was determined to have a traditional policy rather than any deal in investment- bear in mind that 10 years ago, people are very skeptical about unit trust.

The agent persuaded me- because we were friends for long time, I finally relented. But what the agent did was to load up on my premium amount- I paid about RM70 extra every month for the next 10 years. The extra money went into paying mostly for her commision during the first few years but the longer I held the policy, the higher portion of it was being invested in unit trust.

During that time I was one of those busy working person who never read my policy and coverage, so I was not aware of what she did. (Eventually, Central Bank (Bank Negara) became aware of this widespread practice and implemented new requirements- so now insurance agents cannot load up on a person’s premium like what my agent did)

If I had found out about this during the initial years, I would have probably strangled the agent. But through the years, I did nothing about it- unlike some other folks who have time to monitor, withdraw profits, etc- I was too burnt out from my job to care about my finances.

But recently, I’ve gain more control of my life because I’ve decided to take a pay cut in exchange for a life of better quality. So in deciding if I required more coverage, I visited the customer service to inquire about my policy- because I felt that the premium I paid was higher than some of the other people who took up similar policy with me.

And you know what? The customer service told me that todate, the cash value of my policy was almost as much as the premium that I have paid.  That means, all that blissful ignorance hard in fact worked towards my favor. With no withdrawal whatsoever, all profits were added back to the principle and reinvested again and again. Meaning that, if I chose to surrender my policy to get back cash value, I literally get back close to what I had paid for.  It is as if I almost need not pay for coverage! Of course, the unit price of that fund had since risen more than double compared to the time when it was first introduced.  

Technically, the agent was acting according to my wish- to have better savings. Instead being upset with her, I am grateful for what she did.

The moral of the story is force yourself to set aside a little every month just on investment.  You can choose to buy a policy that provides you both insurance coverage and investment, or buy a unit trust that also provides free insurance coverage (usually they do not cover for medical, so you still need an insurance policy that covers for potential medical fees and hospitalization).

But don’t spread all your eggs into one basket- diversify to reduce your risk. Buy sukuk, mutual funds, insurance products and keep some in fixed deposits. Ensure you read the prospectus first before investing.

Ensure the agent explain any parts that you do not understand clearly to you- don’t worry about sounding stupid by asking silly questions. The agent should address all your concerns- after all, it is your hard earned money that we are taking about.

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