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Buying Strategies No1

Written by Nik Rainer | 5 minutes
WED 28-08-2019
Buying strategies to achieve a good over all price for an instrument.

Here we look at 2 ways of achieving effective buying strategy over a period of time. Dollar cost averaging and Dollar value averaging


Dollar Cost Averaging (DCA)
This is a long-term strategy whereby a fixed amount is invested every month (or quarter) in an investment fund or ETF. The strength is in the simplicity because the amount that is invested, 100$ for instance,  does not change. This means that with an "expensive" stock market less or a smaller quantity is bought and with a low stock market price more is bought. On balance you pay a nice average price over a longer period of time.

Benefits
• Realistic way of investing (no starting capital required)
• Virtually no time
• Simple and easy to explain
• The market does not have to be timed
• Transaction costs minimal (periodic order with Binck Fundcoach free)
• Dividend provides a source of income
• Virtually no homework
• Fear and greed play a very minor role in this approach
Cons
• Requires a long-term commitment
• To reduce the risk as capital grows, you must do it yourself
• There may not be enough spread in the portfolio
• The only risk-reducing factors are diversification and a long investment horizon
• Re-investing dividends may require action


Here's an example:
Amount InvestedUnit PriceShares Bought
January$200$1216.67
February$200$1118.18
March$200$922.22
April$200$825.00
May$200$922.22
June$200$1020.00
Total$1200$59124.29

In this dollar cost averaging example, the average price per share over six months is $9.83 ($59 total share price divided by six months). But because of dollar cost averaging, the price paid for each share was only $9.65 ($1,200 total amount invested divided by total number of shares bought).

This means that you are able to sell your shares at anything over the average price $9.65 for a profit.

Dollar Value Averaging
This is a strategy that is getting more and more attention lately. The strategy is also seen as a "further development" of Dollar Cost Averaging and was devised by an American professor. One of the starting points is "Buy low, sell high".

This strategy determines in advance how much the final balance for X years must be. If this amount is known, it can also be determined how much the value of the portfolio should be at the end of each month. What you as an investor do is supplement the portfolio every month up to this amount. In addition, it may even be that the portfolio is worth more than it should be. You have to sell because you are "above schedule".

An example:

Desired final amount over 10 years = € 12,000
This means that theoretically € 100 per month must be invested
After 12 months, the portfolio value must be € 1,200.
However, if the stock market is performing badly at that time and the portfolio value is only € 900, € 300 must be purchased that month (buy low).

However, should the stock market be doing well and the portfolio value is € 1,400 on the reference date (after one year), € 200 will be sold (sell high).

In short, with this strategy you buy extra if the stock market is low and you sell if you are "above target".
Benefits
• Sensitive appeal due to low (extra) buying and (very) high selling
• The final amount is known
• Less capital requirement on balance than at DCA
• This strategy would have better performance than DCA (no scientific consensus is yet)
• The market does not have to be timed
• Dividend provides a source of income that does not have to be paid
• Limited amount of homework
Cons
• More difficult strategy than DCA
• More needs to be calculated
• Additional (very) poor stock market climate must be purchased
• Strategy requires a large cash position
• Requires a long-term commitment
• This approach requires a lot of discipline

Author

Nik Rainer

Nik joined BinckBank in 2016 as part of the team responsible for rolling out the Saxo Bank international service. Nik has held positions at various banking institutions such as Hambros Merchant Bank, Standard Chartered Bank and Morgan Stanley and brings his solid financial background to the role. Working with the development of new client services and relationship management, Nik also contributes to local publications and forums.

The information in this article should not be interpreted as individual investment advice.  Although BinckBank compiles and maintains these pages from reliable sources, BinckBank cannot guarantee that the information is accurate, complete and up-to-date. Any information used from this article without prior verification or advice, is at your own risk.  We advise that you only invest in products that fit your knowledge and experience and do not invest in financial instruments where you do not understand the risks. 

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