Basic Investments
Concepts
Dollar cost averaging (DCA) is the practice of
investing a fixed dollar amount at regular intervals (such as
monthly) in a particular investment or portfolio, regardless of its
price. In this way, more securities are purchased when prices are
low and fewer securities are bought when prices are high. Dividends
from the securities purchased will be reinvested to buy more units.
Dollar cost averaging is best applied on securities with good
fundamentals and over a longer period. Dollar cost averaging could
help you avoid making a lump sum investment at a wrong timing when
the price of stock is high.
Diversification is the idea of not putting all
your investments in one basket to spread out the risk. With
diversification, risk becomes lower. If you do not have
enough funds to buy into a basket of stocks, you may want to
consider buying unit trusts or exchange traded funds (ETFs)
instead.
The power of compounding makes use of the fact
that interest is earned on interest. By choosing an investment with
a fair amount of risk and decent return, you can let time work for
you. Assuming a return of 5% per year and an initial investment of
$1,000:
Year 1 → Annual Returns (%) = 5% → Investment Amount = $1000 →
Annual Returns ($) = $50
Year 2 → Annual Returns (%) = 5% → Investment Amount = $1050 →
Annual Returns ($) = $52.50
Year 3 → Annual Returns (%) = 5% → Investment Amount = $1102.50
→ Annual Returns ($) = $55.13
This translates to an annual return of $50, $52.50 and $55.13 in
the 1st, 2nd and 3rd year respectively. Time is an important factor
in this concept - the earlier you begin
saving and investing, the better it works for you. In the early
stages of your investment program, the rate of return that you earn
on your investments is not as important as the consistency of
systematic investing. As your wealth grows in the later stages, the
rate of return becomes more important than adding new money to your
investment program.
Asset allocation is the practice of spreading
out your investment among different categories such as stocks,
bonds, unit trusts, commodities, cash equivalents and private
equity. By doing so, investors may be able to lessen risk and
achieve a more consistent growth because each asset class has a
different correlation to the others - when stocks rise, for
example, bonds often fall.
Most asset allocation models fall somewhere between four
objectives: preservation of capital, income, balanced, or growth
(in order of increasing risk and return). Selecting the right model
depends on an accurate assessment of your own investment objective,
while picking the right assets to achieve each model requires
extensive knowledge about the risk and return of the different
assets.