- Published on 24 Aug 2015
- - Self Managed Superannuation, Transition to Retirement
Dollar Cost Averaging is a commonly used investment strategy which introduces an investor to the market over a period of time with regular purchases of fixed dollar amounts. This technique is used as an alternative to investing all of your capital as a lump sum.
Dollar Cost Averaging is typically used when there is uncertainty in the markets. Dollar Cost Averaging allows an investor wants to avoid investing a large sum at the “wrong time” and having their portfolio reduce significantly in the event of a fall. Dollar Cost Averaging removes the guesswork of trying to “time the market”.
Essentially, Dollar Cost Averaging is the practice of purchasing fixed dollar amounts over multiple tranches in order to benefit from fluctuations in the market. The regular purchases of fixed dollar amounts allow an investor to accumulate assets over a period of time on a regular basis, often taking advantage of lulls in the market.
With dollar cost averaging, you take a lot of the emotion and fear out of investing because where the market goes in the short-term is far less important to you, as long as you stick to a regular investment plan. If a recession hits the economy and your investment falls in value, you’d just end up buying more shares at a lower price.
Dollar cost averaging is a strategy that is better suited for investors with a lower risk tolerance and a long-term investment view. This strategy is most valuable when used over a long period time with investments that are subject to volatility, such as stocks or Exchange traded Funds, and is less valuable for investments such as bonds or hybrid assets.
The following is an example of how Dollar Cost Averaging works:
Buying XYZ share currently trading at $50.00 per share and you have $100,000 to invest.
You could simply buy the shares at $50.00 and receive 2,000 shares. Or you could use the Dollar Cost Averaging method.
| Amount per Investment | Share price | Shares acquired |
|---|---|---|
| $20,000 | $50 | 400 |
| $20,000 | $45 | 444 |
| $20,000 | $40 | 500 |
| $20,000 | $46 | 435 |
| $20,000 | $52 | 385 |
| $100,000 | Average price per share is $46.21 | 2,164 |
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As can be seen in the above example, you have acquired more shares at a lower cost per share than if you had simply acquired the shares in a single block.
The average price per share is lower (in this example) and you have acquired more shares as well. Of course the opposite is true in a rising market.
For any investment strategy, there are risks associated and it is important to speak to an experienced adviser that can assess your personal situation as well as investment goals and can advise on the best course of action for you.