Introduction:
You may be concerned about the ups and downs in financial markets and are unsure about whether it is a good time to invest in risky assets. Trying to time entry into financial markets can be fraught with danger. Consider dollar cost averaging as an alternative strategy to picking the right time to invest.

What is Dollar Cost Averaging?

Dollar cost averaging involves investing a set amount regularly over a period rather than investing the full amount at a single point in time. This strategy helps avoid trying to time your entry into financial markets. By making regular investments over time, you may be able to minimize the risk of investing all your money during a market peak. This can help to minimize investment risk and average the purchase price of your investments by buying more assets when prices are low and fewer assets when prices are high.

The aim of this approach is to reduce the total average cost of the investments you purchase over time. It allows you to take advantage of choppy or falling financial markets by investing gradually over a period. If investment prices fall over this time, you can buy investments at a lower price and receive more units or shares for the fixed sum of money.

By placing the money intended to be invested in a cash account until you are ready to make the regular contributions, you will start to earn some income to help boost your savings.

Example:

Isa has received a windfall of $100,000 and decides to invest it sensibly in shares rather than spend it. She decides to invest a regular sum of $8,333 each month over a 12-month period. Her investment balance will depend on how the share market performs over the next year.

To illustrate, we have assumed three scenarios for the performance of the share market:

1. The share market rises steadily by 20% over the year (unit/share price increases from 1.00 to 1.20 by the end of the year).
2. The share market is choppy and steadily falls by 20% in the first six months before steadily rising in the second half of the year to the same level as it was at the beginning of the year (unit/share price starts at 1.00, falls to 0.8 by the middle of the year, and then ends at 1.00 by the end of the year).
3. The share market falls steadily over the year by 20% (unit/share price falls from 1.00 to 0.80 by the end of the year).

Isa invests the $100,000 into a cash account that pays an interest rate of 2% pa and draws down $8,333 from this cash account every month to invest in the managed share fund. At the end of the year, the value of her investment is as follows:

• If the market had risen over the 12-month period, Isa’s portfolio is estimated to be worth $109,359 using the dollar cost averaging strategy. She has gained from the rise in the share market but would have performed better if she had invested the full $100,000 at the beginning of the year, in which case her portfolio would be worth $120,000.
• If the markets had fallen over the period, Isa invests at progressively lower prices, and her portfolio is expected to be worth $89,439. She has lost money on the investment but has not lost as much as if she had invested the full amount at the beginning of the year (in which case, her portfolio is estimated to be worth $80,000).
• If the markets are choppy, Isa takes advantage of the prices when they fall and then recover, such that her portfolio is expected to be worth $109,932 (compared to $100,000 if she invested the full $100,000 at the beginning of the year).

This example shows that dollar cost averaging can add value when markets are choppy or falling compared to investing the full amount at the beginning of the period. However, if markets rise consistently, then dollar cost averaging is less effective than investing the full amount at the beginning of the period.

Risks of Dollar Cost Averaging:

• If markets rise over the period, dollar cost averaging is not as effective as investing the full amount at the beginning. This is because you could have invested a larger sum at the lower price and benefited from the full extent of the rise in the price of your investment.
• If the price of your investment falls, your total investment will suffer losses, and you will have a lower balance compared to the total amount you invested. However, this loss is likely to be lower than if you invested the full amount at the beginning of the period.
• The ‘dollar cost averaging’ approach relies on your commitment to make the same regular contribution into the riskier investment for the set period. If the investment price falls and you decide to stop making these regular contributions and/or sell your investment, you will realize a capital loss. If the investment that you sold subsequently recovers and gains in value, then you will not benefit from the subsequent growth in returns.

The information contained in this article is general information only. It is not intended to be a recommendation, offer, advice or invitation to purchase, sell or otherwise deal in securities or other investments. Before making any decision in respect to a financial product, you should seek advice from an appropriately qualified professional. We believe that the information contained in this document is accurate. However, we are not specifically licensed to provide tax or legal advice and any information that may relate to you should be confirmed with your tax or legal adviser.