Harness the power of dollar cost averaging
- Financial Planning
Growth markets, such as shares and property, will always have a natural tendency to fluctuate. Everything from the economic and political environment, to the sentiment of investors can see values move up and down; sometimes quite suddenly and dramatically. This can lead to some investors being understandably nervous about ever entering share and property investments.
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This inherently volatile aspect of growth investments can lead some investors to think that the only way of making gains is to keep a constant eye on market movements and rely on good fortune, so they can time their entry into the market to perfection. While it is important to be aware of market movements and to assess how different companies, industries and sectors are performing, there are other ways to successfully invest in growth assets that doesn’t rely on perfect timing and actually turns the fluctuations into a positive.
‘Dollar cost averaging’ can do this for you
The name might sound a little obscure and technical, but the principle of dollar cost averaging is a simple one that all investors can use. It can produce powerful results for those interested in including growth assets in their personal portfolios.
Put simply, dollar cost averaging is the practice of staggering your investments at regular intervals into the growth component of your portfolio. As the market ebbs and flows, some of your purchases will be gaining the advantage of buying at a discount, while other deposits will be buying at a premium. The cumulative ‘averaging’ effect on the price you buy at reduces the risk of mistiming your investment and making all of your investment at a particular time when the market is at a peak.
Let’s look at an example
To illustrate how this concept can work in practice, let’s look at a simplistic example. Imagine that you have $1,000 that you want to invest in a growth investment. The table below shows the results over a ten month period of investing upfront, compared to investing with a dollar cost averaging approach.
Scenario 1 involves investing the full $1,000 at the start of the first month, while scenario 2 staggers the investment in lots of $100 at the start of every month.
* Rounded to two decimal places
During the 10 month period the unit value fluctuated quite dramatically above and below the initial $10 starting price. In scenario 1 after 10 months the investor ends up with exactly the same amount that they started with. By dollar cost averaging in scenario 2, the investor has made a profit of $90.50 without any additional skill or market knowledge - they simply drip fed their investment, so that they would benefit from investing when the price dropped. Even though they were also buying when prices were high, the net effect was an overall gain.
Will it suit your situation?
While there are no guarantees that dollar cost averaging will ensure gains, it is one way of reducing the risk involved in growth investments and it effectively takes advantage of the fluctuations, without having to predict them.
Dollar cost averaging does not do away with the need for sound research and careful allocation of a portfolio to meet your specific timeframes and objectives, but it can form a valuable role within an overall strategy. The best idea is to discuss dollar cost averaging with a professional financial planner, who can assess if it is appropriate for your situation.
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