Cost Averaging & Crystallization

Many people are afraid of investing in stocks, particularly when the markets are bearish – like now. Yet everybody recognize that the best time to buy markets is when they are cheap. Unfortunately, unless you follow the markets on a daily basis – and even so – you never know when to buy a stock. The simple thought of bad-timing scares many off investing in stocks.

Yet, a smart investors have a few techniques and strategies in their arsenal to protect themselves against market-timing and enjoy a more aggressive investment strategy with relatively low-risk: Dollar Cost Averaging and Crystallization.

Dollar Cost Averaging (DCA)

DCA is a strategy where you buy a fixed amount of the same share on a regular basis, usually monthly. It enables you to not be subject to bad market timing, helping you reduce your risk exposure. After all, you are sure to not buy a market at the wrong time as you will balance your investment the following period with the same amount of dollar. When your share’s price is going down, your dollars will buy you more shares. Of course, the contrary is also true. You buy less share when their value goes up. You end up with a slightly lower average cost, assuming the fund fluctuates up and down.

It is a very sensible approach, especially when you are starting to build up your wealth. As an example, it work great when you want to prepare yourself for retirement and decide to commit yourself to investing a fixed amount of your salary every month. It shouldn’t come as a surprise that it is a very popular strategy among investors, brokerage firms and mutual funds.

Yet, as with every strategy, it does not work every time. Some studies and analysis (here and here) have proved it to be no better than single investment when considering a single fund or investment. True enough enough, this strategy is not a panacea. But if you counter-balance its draw back with a Diversification / Crystallization Strategy, it can work wonders.

Diversification / Crystallization

The Diversification / Crystallization Strategy is pretty simple in its concept and work in two steps.

The first is to diversify your investment across a few companies, markets and sectors. You need to consider multiple companies in multiple sections across multiple markets so as to manage your risk along the way. The old fashioned “don’t have all your eggs in the same basket” advice.

The second is to review your portfolio on a regular basis and make adjustments. After a few months, you will realize that some of your position will be reaching for the sky, other have stagnated (or gone up slightly), when others started digging themselves nice little holes. The Crystallization part kicks in when you realize your profit on the ones you think have peaked. You then can re-invest this money in a new position or strengthen an existing promising one. Most of your other positions will remain the same, waiting for their time. You somtimes will have to cut your losses on a bad position. But thanks to cost averaging, your losses would not be as bad as they could have This help you optimize your profit as you sell when the market is up and minimize your bad luck thanks to cost averaging.

Pretty straight forward concept isn’t it? And the great part is that once nicely set-up, it work on its own. Select the right platform to invest with. Choose a few markets / funds that you like. Arrange for a direct transfer to buy your shares / funds once you receive your monthly income. Sit back in your chair, and simply wait a few months before reviewing your positions. No magical tricks, simply a nicely set up strategy which you stick to.

N.B. 1 – These strategies will bail you out of a declining market, you will still lose money. Nor will it get you fully invested in the earliest stage of a rising market. But you don’t have to ask yourself when to start. Tomorrow is as good a time as ever. It even is better than the day after as you can rip the benefits of your commitment earlier!

N.B. 2 – My crystallization strategy is quite different from the common one. To read more on the common meaning of crystallization in finance I invite you to check the following Investopedia article.