Why Dollar Cost Averaging on an ETF Makes Absolutely No Sense

Uncategorized Jan 08, 2018

by: Tam Ging Wien

- Misconception or is there Something More Sinister?

Recently I came across a product sold by POSB called Invest-Saver which is a monthly savings plan designed to allow you to invest in ETFs using a dollar cost averaging strategy. They painted the benefit that this product is convenient (auto deduction without needing to open a trading account), affordable (minimum of $100 per month) and a long-term savings using the advantage of dollar cost averaging.

I could understand convenient, I could understand affordable. But, this product got me thinking about the last benefit; could you beat the market if you invested an index that actually tracks the market? What’s more, using dollar cost averaging means that I would make my investment purchase at fixed time intervals. Somehow, this seems contradictory to me! How it is possible to beat a market index by investing in a market index and fixed intervals anyway?

A quick search on the internet appears to show that many other financial institutions are also offering a similar products. Phillip Capital has a Phillip Share Builders Plan and DBS has their ETF Regular Savings Plan.

So to test my theory, what I did was to compile the list of monthly closing prices of the SPRD STI ETF since Jan-2008 till Dec-2016 and plotted the chart using Excel.


Source: Yahoo Finance (https://sg.finance.yahoo.com/q/hp?s=ES3.SI)

Using a hypothetical scenario of investing a fixed $100 at the beginning of each month, I would purchase units in the ETF using the closing price. After 9 years, I would have spent 109 months (I know that’s 1 month more than 9 year, but that the data from Yahoo!) accumulating 3750 units and at the closing price of $2.94 on 30-Dec-2016, my value would have stood at $11,025. Investing a total of $10,900 in total over the 9 years returned me a measly 1.15%! That’s hardly market beating returns!

Accounting for the dividends which I would have received, I would end 30-Dec-2016 with $12,094.55. That’s just under 11% over 9 years; that’s just 1.16% CAGR! According to SDPR’s fund information on the SPDR STI EFT (http://www.spdrs.com.sg/etf/fund/fund_detail_STTF.html), the fund performance at of 31-Dec-2016 was 2.66% over the last 10 years. This implies that the dollar cost averaging strategy on the STI ETF is actually underperforming the market!

This simple theoretical exercise enforces my believe that you cannot beat the markets by investing in a market tracking benchmark using dollar cost averaging. If this true, why didn’t the professionals notice this? Why are the banks and other funds still marketing this strategy to potential investors? Beats me. Maybe the fund professionals have other ways of using this strategy that I am not aware of.

But then, my interest got me thinking. Is there a simple way to beat the market using ETFs and is also convenient and affordable? I decided to modify the dollar cost averaging strategy to “Buy Below Average Price Strategy”. The strategy is simple. I took monthly closing prices of the ETF over the 9 years and found that the average price is $2.977. I would then do a dollar cost average strategy only when the ETF is below this average price.

To my surprise, this simple strategy tweak more than doubled my returns! It’s a really easy implementation of the “buy low-sell high” strategy. After 9 years, I would have accumulated 1786.4 units at a cost of $4,600 and valued at $5,250. That’s a 14.1% return! Accounting for dividends of $496.20, the return would be just under 25% or a CAGR of 2.51%.

However, this strategy had a problem, it means that my capital of $10,900 is not fully invested over the 9 year period. I tested another tweak to the strategy which I call “Double-Up Below Avg NAV Strategy” after observing that the total invested amount is approximately halved. Instead of investing $100 each time, you would double up the investment to $200 each time the monthly closing price trades below the average price of $2.977.

Using this modified strategy for the 9 year period, I would have accumulated 3572.8 at a cost of $9,600 and valued at $10,504.01. Accounting for dividends of $992.40, the total return is $11,496.44 still preserving the 25% return (CAGR of 2.51%) while still investing close to the capital of $10,900.

I would conclude by saying this, ETFs are no doubt a good way to invest if you want to keep your investments simple. However, mixing a dollar cost averaging strategy with ETF investing is not the way to go. Instead, consider simple using the “Double-Up Below Avg NAV Strategy” explained above. It’s simple to follow and will not take you significant time to determine the historical average prices of the ETF of your choice.

Download the Excel worksheet used.

 

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