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.