Investing your money can produce large returns in the future. There are several ways you can go about investing without investing a lump sum. In dollar cost averaging, or DCA, the investor invests the same amount in a period of time. A variation on DCA is called value averaging, or VA.
Goal of Value Averaging
The goal of value averaging is to gain more shares when prices fall, and gain fewer shares when prices rise. Some studies have shown that over time, VA results in larger returns compared to DCA. For every period of time, the investor sets how much he would like to invest. The goal is to stay on this “value path” for every period of time.
Take an investor who stays on a value path where he contributes $1000 more each month. After he purchases the first set of shares in the first month, his ending market value may be $1200. As a result, he must only invest $800 for the next month to reach the goal of $2000.
Downsides to Value Averaging
One of the biggest downsides to value averaging is the potential to hit a shortfall. Shortfalls occur when the amount of funds the investor has available is less than the target investment amount. VA is also not as straightforward as DCA. With every period of time, you must calculate the new amount you plan to invest. The plan requires discipline despite your hesitation, which is a factor you must consider, especially in a frenetic market. You should also keep in mind that VA is a more complicated strategy than DCA.
One of the best ways to navigate your investment opportunities and strategies is to hire an investment consultant. For those who are looking for a professional investment consultant in Singapore prepare for the meeting by knowing how much you plan to invest, for how long, and the goals you want to accomplish on your returns.
Goal of Dollar Cost Averaging
DCA is very similar to VA in that you purchase more shares when the prices are low, and less shares when the prices are high. The main difference between DCA and VA is that with VA, you invest the same amount every month.
For example, consider an investor who wants to invest $2000 every month into a particular fund. The share price of the fund varies over the course of three months. During the first month, the share price is $30, during second month, the share price is $35, and during the third month the price is $32. The investor would then calculate how many shares he has to buy every month according to his $2000 investment. Dividing this amount by the cost of the shares, he then purchases 66.67, 57.14, and 62.5 shares across the three-month period.
Downsides to Dollar Cost Averaging
An issue with DCA is that you risk losing higher returns when the investment rises after the initial period. Another issue with DCA is that it may not be the best long-term strategy. It is also not an effective way to invest large sums.