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Dollar Cost Averaging: Trick of Buying in Installments!

If you are googling the word 'Dollar Cost Averaging (DCA)' on the internet, the definitions of the word may vary. However, my definition of DCA is, ‘Continuously buying a particular stock, little by little, with the aim to own the shares as much as possible’. If you already own a sizable share, then what? Well, you can just hold the stock. The profit you seek is no longer in the form of rising price of your stock, but the annual dividends distributed by the company. When you own a particular stock in small amounts, then the dividend may be too little. But a large ownership of a company, of course, will produce large dividends.

The concept of DCA is suitable for those of you who have a number of monthly income, which after daily necessities and others, you could save some money (actually, even if you are a fresh graduate employee with a very small salary, I still recommend that you could set a part of your salary for savings. My first salary in 2008 was Rp1.6 million or about US$ 160 per month, and I was able to save US$ 40 of them. I never thought of the saving money would be used to buy anything, because my purpose is that I have savings, that's it).

This money then can be saved in the shape of productive assets, in this case the shares of a company that is able to make net profits consistently from year to year. If in a month you could save US$ 100, for example, then for the first phase you can buy shares worth US$ 100. In the next month, you can top up aka buy the same stock, no matter how much it costs at the moment, also worth US$ 100, so now you are holding shares worth US$ 200. And so on, you buy the same stock each month, thus after one or two years, you would hold your stock in large quantities.

And after a few years, you might be able to live only from the company's dividend that you receive.

Although never explicitly mentions the DCA, but Warren Buffett is one of employer of this investment strategy. In one of his annual letter in the 1960s, when he was still running the Buffett Partnership where he manages funds belonging to his friends, Buffett said, "I would rather have to pay interest plus the return on investment to fund owners in the Buffett Partnership, rather than borrow money from the bank even though they charge a lower interest rate. This is because I don’t receive funding (from the partners) at once, but little by little. Every time I get a new partner, then that’s the time Buffett Partnership received new funds that can be directly used to buy stocks. As a result, I could buy stocks (that had previously targeted) on a continuous basis, and also able to average down if the price drops. The story would be different if I receive a loan from the bank at once, where at later times I can not obtain any more funds, so I can only buy a certain stock at a single time. If later the stock price goes down, I do not have the funds to buy more at lower prices.'

In essence, Buffett said that he likes to buy shares in installments. This installment method makes him possible to buy more when the price (of the targeted stocks) down, and only buy a little when the price is high. This buying method is automatically reduces the risk of loss due to fluctuations in stock prices, which can occur at any time. In Buffett's view, regardless of the price of stock that could go up and down all the time, but a stock that representing a good company will eventually rise in the long run.

Now, you can also practice the concept of buying shares in installments on your personal investment activities. It’s very simple, when you try to invest in stocks for the first time, then you may use a small fund first, right? Later, when you have more money, then you can deposit the money into your account in securities to buy more shares. If you see that the price of you stock is high, like when th Jakarta Composite Indes (JCI) was bullish, then you can hold on your cash position, or still buy the stock only in a less quantity. When the market goes down, and your shares also fell, that’s when you can buy the stock in bulk. This strategy, once again, allowing you to make a profit every time the stock price was down, instead of suffering a loss.

Then how can the DCA strategy generating quite large profits, or at least able to beat the performance of the market/JCI? Well, that's because a number of good companies in Indonesia, if you notice, has real growth rates that are higher than the average growth of the market. What I meant by real growth is the growth in net assets/equity plus paid dividends. Some 'super companies' like Astra International (ASII), Bank BRI (BBRI), and so on, has growth rates of more than 20% per annum, or higher than the growth of JCI which only about 12% per annum (calculated since the JCI launched in 1982).

And although the share prices of a company can go up and down all the time, including could fall if the JCI is dropped, but in the end the price of a stock will follows the real growth of the company. So if the real growth of the company (which you buy the shares) is higher than the increase in JCI, then the performance of your investment will also, eventually, higher than the market growth. You do not have to worry about buying shares at a too high price, because through the DCA strategy, you can accumulate a stock by buying it at a predifined time no matter the price was high or low (so that the average purchase price will be in the midst), or with slight modifications: Only buy a little when the price is high, or not at all, and buy more when the price is low.

The main difficulty, of course, is when we choose which stocks that we are going to take. Because in investing with DCA style, you must have the intent to hold your stock forever, and will not sell it for the reason of profit taking or else. The problem is, it is relatively easy to hold certain stock when the company’s performance was good, and the stock price continues to rise. But what if it just dropped, especially if at the same time, the JCI was still gaining?

Therefore, the most important task in applying this DCA is by make a rigorous selection of the stock which you would take. There are many criteria of a good stock, which we’ve discussed many times on this website (for example, in the article about intrinsic value, the criteria of good stock, and quality management). One more tips: Do not compromise with the quality of the company's fundamentals, and only select stocks that you think are the best of the best, that you are willing to ‘live happily ever after with it’, both in difficult (sluggish business, the market falls), and happy conditions (business runs smoothly, prices rise, stock market bullish).

While my old friend, who has implementing the DCA for a long time, once said this: Only buy shares of a well-known company, which the name of the company is known by many people, both stock investors and common people.

However, there is never a perfect investment strategy, including DCA also has some weaknesses. One of them is if the company (that you choose), after some time did not produce real growth as expected, or even making losses and business setbacks, then your loss will be very big, because since the very beginning you had kicked out the option to sell the stock. And in fact, only because a company has a brilliant and consistent track record of performance in the past, then it does not mean that it is guaranteed to continue to survive in the future. Lehman Brothers, Inc. is a giant investment banking company that has a bright track record since 1850 (sooo long ago), including could survive in the event of Great Depression in the 1930s, but still, it went bankrupt in 2008. While in Indonesia, there is Berlian Laju Tanker (BLTA) which was one of the leading blue chip stocks in the 1990s, but now it bankrupt too. Make no mistake, some of my friends are still stuck in this BLTA until now.

Another weakness is, when you are only pursuing a consistent growth that beat the market, then you may lose momentum to buy stocks that, at certain periods, offering a higher increase than just twenty or thirty percent per year, though in another period they stop rising or even fall back. For example in the year 2009 - 2011, the coal and palm oil plantations sectors were booming, and at the time almost all the shares in the two sectors experiencing growth that is far much higher than the average increase of the JCI. Although after 2011 the two sectors lost their glory, but if there were investors who are quite keen to get into these coal and oil palm plantations in 2009, and then implement the exit strategy when the time is right, then he would make more profits than most of other investors, including the implementers of DCA.

Thus, to minimize the risk of DCA (if the selected company did not fulfil your long term expectations), while still maximizing the profits (from stocks that offer higher growth than the average, which you would sell it when the time is right), then you can combine DCA with other investment method, of course, that you mastered. The point is, if you can find one or two stocks that you are pretty sure can hold them as long as possible, no matter the price goes up or down (you better choose blue chip stocks, read the explanation here) so you can buy it continuously without ever sell it at all, then do not use all the funds available to buy the shares, but leave some to invest using different strategies/methods, such as (like I usually do) buy stocks when the price is undervalue, or buy stock that representing a small company which offers significant growth to be great someday.

But if we look at the experience of some old timer, including my own experiences, then we should, indeed, have one or several stocks that we are committed to holding it as long as possible, and are willing to buy more (add the ownership) every time the price was low. You may ask experienced investors, they usually always have at least one stock that they’ve been holding it for years, never sell it, and they always buy it again every time the price was low, like in the event of bear market. And the result? They made several folds of profit! So why don’t we try the same strategy?

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