IT may surprise you to know that even a slight upward bump in long-term yields can make a huge improvement in total future returns.
This is my 100th weekly Money Thoughts column for the New Sunday Times. I’m delighted to reach this milestone.
I find it fascinating that in the short span of the last two years I’ve written this super-fun (at least for me!) column that there have been extreme developments on the domestic, international and personal fronts!
Malaysia, with its open
economy, sensitivity to oil prices and susceptibility to sensationalism, made international headlines for good and bad reasons; Donald Trump, in the weirdest election upset of our lifetime, was elected POTUS (President of the United States); and last year, I lost my beloved mother in August and my respected father-in-law in November.
We all look at life through a lens crafted by our pain, prejudices, preferences and perceptions. That’s why I’m sure the last couple of years has been a time of oscillation for you.
Such up and down, and up and down, and up and down patterns are our way of life on Earth. That’s true for the macrocosm of all human existence and for the microcosm of investing, particularly long-term investing.
Therefore, for this 100th instalment of Money Thoughts we’ll focus on an investment strategy for long-term wealth building that works best in zigzagging or oscillating markets. It is referred to as DCA, which stands for Dollar-Cost Averaging.
LONG TERM WEALTH BUILDING
When carried out successfully, DCA increases the CAGR or compounded annualised growth rate of a portfolio. Such investments may include shares of a listed company or of REITs (real estate investment trusts) or units in an international or domestic unit trust fund. (Note: When one investment approach generates an average annual growth rate of x per cent and another approach yields (x+0.5) per cent, we refer to that 50 basis point increase as half a percentage point yield enhancement, which sounds modest but over many years its snowballing effects are monumental.
Yield enhancement is a mega boon to personal wealth accumulation over extended periods. For example RM1 million growing at 4 per cent a year over 50 years compounds to RM7.1 million; but if it were to grow by just one percentage point more, 5 per cent per year, that amount would balloon to over RM11.4 million!
DCA can often (but not always because of investment risk) deliver yield enhancement to our long-term portfolios, especially those with time horizons ranging from seven to 40 years and beyond.
The extra money that may be made through DCA is sizable.
You see a bump in CAGR from say 5 per cent to 6 per cent over a 10-year investment time horizon for a child’s tertiary education fund can spell the difference between a 3+0 (all three years in Malaysia) and an ostensibly better 2+1 (two years in Malaysia plus one year abroad) twinning degree for your daughter or son!
And if compounded returns are permitted to build up even longer, you may see a CAGR improvement from, say, 6 per cent to 7 per cent over a 20-year retirement
funding period, which in practical terms could spell the big difference between a stark and a comfortable retirement.
(I’m grateful to be writing this column early this month while vacationing in Kamakura, the ancient city that was the capital of Japan 900 years ago. To a large extent I am able to take this short break because of the incremental yield on my personal long-term wealth accumulation portfolio, which so far has benefited from more than two decades of DCA-enhanced returns.)
Not surprisingly whenever I have a wide ranging conversation about investment strategies with potential and new clients, I make it a point to discuss the power of DCA. I sometimes extend such conversations to introduce another strategy called VCA or value-cost averaging. (For a summary of both investment approaches, download my free e-report deciphering the DCA-VCA Code at www.freecoolarticles.com/giftcentre.htm)
DECIPHERING DCA
For those who wish to put in place an emotionless long-term strategy with minimal human interaction, DCA is superior to VCA because the latter requires significant monitoring and tweaking. In contrast, automating a DCA programme is simple.
When I teach the mechanics of DCA in my investment planning and financial planning workshops I explain that five criteria must be met to increase the odds of DCA generating yield enhancement over long periods of more than seven years. Those crucial conditions are:
1. Always buy a high quality asset, not a rubbishy one;
2. Always select, for the purpose of yield-enhancement, an investment asset that fluctuates in price;
3. Pump in equal amounts of money into your chosen asset;
4. Do so at equal time intervals; and
5. Commit to continue doing so regardless of market conditions.
(I’ll end this column soon to get back to my holiday. But before I leave you, please figure out if you have been using DCA properly.)
You may choose to show this column to your investment adviser or financial planner.
If so, please use what I’ve explained to you as a launch pad for a discussion on how to reduce your risk of investing while aiming to increase your long-term returns.
You see, doing so can radically improve your quality of life in the decades ahead. Happy investing!
© 2017 Rajen DevadasonRead his free articles at www.FreeCoolArticles.com.
Connect on rajen@RajenDevadason.com, www.linkedin.com/in/rajendevadason, and Twitter @RajenDevadason