For the past two months in this column, we’ve been discussing an investing technique known as dollar-cost-averaging (DCA). This approach involves making set contributions into one’s investment account at pre-determined time intervals (for example, $300 every month). A primary benefit of DCA is that it frees an investor from perpetually wondering whether now is “a good time to invest” because that decision has been made in advance.

Last month, we explained how DCA can take advantage of market downturns and use them to the long-term benefit of DCA investors. This month, we conclude this series on DCA with some nuts and bolts application. Dollar-cost-averaging can be applied to all of SMI’s various strategies, although some of them present greater logistical challenges than others.

As we have noted, one of the primary advantages of DCA is the ability to automate the investment contributions. These automatic contributions are more easily made into a single constant fund, as opposed to being made into a portfolio of several funds that are occasionally changing as part of an actively managed strategy. Because of this, those interested in automating the DCA process may be best served investigating the automated vehicles that are available for certain SMI strategies. But for those who prefer to manually implement the strategies (that is, be actively involved in handling the monthly transaction details), here are some pointers.

Generally speaking, there’s a trade-off to be made between traditional mutual funds and ETFs when it comes to DCA. ETFs offer flexibility because they have no minimum purchase requirements, but they can be more expensive if a commission is charged with every purchase. On the other hand, while traditional mutual funds often can be purchased with no fees (depending on the fund and where the account is set up), they may have a minimum holding period which can complicate the DCA process.

  • Just-the-Basics (JtB)
    This index-fund strategy is the easiest of the SMI strategies to use with DCA. ETFs are our recommended vehicles for this strategy, primarily for the benefit of investors getting started with small amounts. However, all of the ETFs used in JtB also are available in traditional mutual-fund share classes which are easier to work with if you plan to make monthly DCA contributions. In fact, setting up an account with Vanguard and establishing regular contributions from your bank account into each of the recommended JtB mutual funds makes investing about as easy as it gets.
     
  • Dynamic Asset Allocation
    This strategy utilizes ETFs, which means it is relatively easy to DCA into with a small starting amount. However, if the regular DCA purchase amounts are too small, the ETF commissions (which generally run $7-$10 depending on the broker) can be quite expensive as a percentage of each contribution.

    One way to minimize this expense is to buy only one of the recommended ETFs with each purchase rather than buying all three every time. This will cause the portfolio to be slightly out of balance temporarily. But if you rotate the purchases, the one-at-a-time approach shouldn’t impact overall returns much, and it will definitely save on commissions. Readers making DCA investments should also check the DAA Recommendations page to see if any of the recommended ETFs (or close substitutes) can be traded with no commissions at their broker.
     
  • Upgrading
    This is the most difficult SMI strategy to make compatible with DCA. That’s due to the number of funds involved, plus the fact that most recommendations are traditional mutual funds with broker-imposed (and sometimes fund-imposed) holding periods. This means when an Upgrading recommendation is replaced, you likely will have at least a couple of recent DCA purchases in that fund that are going to run afoul of the short-term trading restrictions at your broker (and if the fund charges a short-term redemption fee, at the fund company as well). Because of this, Upgrading is a particularly appealing choice for automation rather than manual implementation.

    Otherwise, the same idea suggested for DAA may be helpful here: rather than trying to buy a small amount of every recommended fund with each purchase, you might rotate your purchases and buy only one or two funds each time instead. Even doing this, you’ll still need to keep close track of your purchase dates and will likely pay a small short-term redemption fee on a portion of your holdings from time to time. Fidelity is a strong choice for those wanting to manually DCA into Upgrading due to their shorter-than-most 60-day holding period for no-transaction-fee mutual funds.
     
  • Sector Rotation
    This is a relatively easy strategy to DCA into because only one fund is owned at any given time. Sometimes the recommendation will be a traditional fund, with some of the same short-term trading issues common to Upgrading above.

    At other times, when SR recommends an ETF, the commission may be relatively expensive if the purchase amount is small. The probability of smaller purchases is higher with SR than the other SMI strategies because, due to the higher risk, we suggest limiting the SR allocation to no more than 20% of the stock portion of your portfolio. In the event of a small SR allocation, making less frequent (but larger) purchases may help eliminate that problem.