We often mention dollar-cost averaging to our clients as our preferred method of investing funds into the share market but it’s helpful to understand exactly what this term means.
Simply, dollar cost averaging is the process of investing a fixed amount at set intervals. The alternative to this approach is attempting to ‘time the market’ and subsequently investing a lump sum when you believe the market has reached a low point. The aim of dollar cost averaging is that the average cost of the investments will be below the average value of the investments during the period in question. Over time the costs average out as you’re buying units when the price is both high and low, so the investor usually ends up with more assets than if they were timing the market.
This is our preferred approach when clients have a lump sum to invest. If you’ve ever spoken to our advisers about investing a significant lump sum, it’s common to hear a proposal of 4 tranches over 12 months or a similar approach.
While there are cost benefits to be had from this method, dollar cost averaging is also useful for an investor’s mindset as it removes the emotional component of the decision-making process to try and pick the cheapest time to invest. Over the last 100 years global share markets have experienced many major setbacks, including the Great Depression of the 1930s, several wars, the ‘crash of 1987’ then the Global Financial Crisis twenty years later. But for every low, a recovery has followed – they just take time. What stops most people from investing in (or returning to) the share market is not knowing when to jump in. Although nobody knows exactly when a market or a particular share price has found its base price, we can employ a strategy to remove this speculation and focus on a longer-term investment plan.
Dollar cost averaging is also a suitable strategy for investors who don’t have a large sum of money to invest immediately but are able to build up an investment portfolio over time. It also encourages discipline – once you have committed to the principle of regular investment, you are more likely to accumulate a useful asset than a pocketful of good intentions.
If you would like further information on this topic or would like a personalised discussion about the most appropriate investment approach for you, give one of our advisers a call.