Why little and often can be a smart investment strategy
When markets are volatile and spare cash is not flowing freely, setting aside money to invest in your future might not be a top priority.
But continuing to invest, in whatever small way you can, can make good sense in the long run.
Enter dollar cost averaging, an approach to investing that doesn’t require a large lump sum or nerves of steel.
How does it work, and what are the trade-offs? We take a look below.
How dollar cost averaging works
Rather than investing a lump sum of money at one time, dollar cost averaging is essentially investing smaller ‘bite-sized’ fixed dollar amounts into an investment at regular intervals, no matter what the unit or share price is doing at the time. The aim is to minimise the potential market timing risk of investing a lump sum amount at a given time.
Through dollar cost averaging, more units or shares are purchased when prices are low, and less units or shares are purchased when prices are high. The idea is that over the course of the investment timeframe, there are multiple entry points, and potentially a lower average price paid for the total amount of units or shares purchased.
It can be a useful strategy to help take the emotion and stress out of investing. Because dollar cost averaging is automated and structured, it can help take away the worry and also feelings of regret if you invest a lump sum right before a market downturn, or miss out on an upswing. Importantly, this ‘bite sized’ approach can also give your investing some momentum without the need to find a lump sum of money (which can be useful if you don’t have it).
Dollar cost averaging can tend to work best when you are prepared to patiently ride investment market volatility, and stick to the plan. Here’s a simplistic example based on the purchase of shares:
|Month||Investment||Share price||Shares purchased|
Let’s say you invested $1,250 over five months using a dollar cost averaging approach. At the end of month five, you own 67 shares, and have paid an average of $17.80 per share. If you had invested a lump sum of $1,250 in month one, you would have paid $20 per share and own just 62 of the same shares. In this example, by using the dollar cost averaging approach, you have come out ahead.
Of course, this doesn’t always happen. In the example above, if the share price were to continually rise after month one, then you would own less shares at the end of the 5-month period, having paid a higher price per share.
Things to bear in mind
While dollar cost averaging can help protect you from market fluctuations and minimise market timing risk, investing regularly in a share or fund that continues to fall, and has poor prospects for future income or growth, can be unwise.
Something else to bear in mind is that dollar cost averaging, in isolation of an initial lump sum investment, can mean delaying the rest of the money you potentially have to invest, and therefore its exposure to the markets. Of course, if you don’t have a larger lump sum of money lying around ready to invest, this may not really be a trade-off for you. What’s important is that you’re continuing to invest where you can.
There is, of course, also the risk that any money you don’t invest at the outset, is spent or re-directed elsewhere. To keep the momentum going, you really need to be diligent and consider prioritising your investing as a non-negotiable item in your budget.
As always, whether the dollar cost averaging approach makes sense for you really depends on your own personal circumstances, including your risk tolerance and capacity, and the amount of spare cash you have at your disposal. If investing a lump sum of money fills you with fear, or you simply don’t have it, then dollar cost averaging might be something to consider. Investing some money may be better than not investing at all.
This report is prepared by Bridges Financial Services Pty Limited ABN 60 003 474 977 AFSL 240837 (Bridges). Bridges is an ASX Market Participant and part of the IOOF group of companies. This report is prepared by the IOOF Research team for: Bridges Financial Services Pty Limited ABN 60 003 474 977 AFSL 240837, Consultum Financial Advisers Pty Ltd ABN 65 006 373 995 AFSL 230323, Elders Financial Planning ABN 48 007 997 186 AFSL 224645, Financial Services Partners ABN 15 089 512 587 AFSL 237 590, Millennium3 Financial Services Pty Ltd ABN 61 094 529 987 AFSL 244252, RI Advice Group Pty Ltd ABN 23 001 774 125 AFSL 238429, Shadforth Financial Group Ltd ABN 27 127 508 472 AFSL 318613 (‘Advice Licensees’). The Advice Licensees are part of the IOOF group comprising IOOF Holdings ABN 49 100 103 722 and its related bodies corporate (IOOF group). The Advice Licensees and/or their associated entities, directors and/or employees may have a material interest in, and may earn brokerage from, any securities or other financial products referred to in this document or may provide services to the company referred to in this report. The document is not available for distribution outside Australia and may not be passed on to any third person without the prior written consent of the Advice Licensees. The Advice Licensees and associated persons (including persons from whom information in this report is sourced) may do business or seek to do business with companies covered in its research reports. As a result, investors should be aware that the firms or other such persons may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as a single factor in making an investment decision. The document is current as at the date of issue but may be superseded by future publications. You can confirm the currency of this document by checking the intranet site (links below). The information contained in this report is for the sole use of advisers and clients of AFSL entities authorised by the Advice Licensees. This report may be used on the express condition that you have obtained a copy of the Advice Licensees Financial Services Guide (FSG) from their respective website. Disclaimer: The information in this report is general advice only and does not take into account the financial circumstances, needs and objectives of any particular investor. Before acting on the advice contained in this document, you should assess your own circumstances or seek advice from a financial adviser. Where applicable, you should obtain and consider a copy of the Product Disclosure Statement, prospectus or other disclosure material relevant to the financial product before making a decision to acquire a financial product. It is important to note that investments may go up and down and past performance is not an indicator of future performance. The contents of this report should not be disclosed, in whole or in part, to any other party without the prior consent of the IOOF Research Team and Advice Licensees. To the extent permitted by the law, the IOOF Research team and Advice Licensees and their associated entities are not liable for any loss or damage arising from, or in relation to, the contents of this report. For information regarding any potential conflicts of interest and analyst holdings; IOOF Research Team’s coverage criteria, methodology and spread of ratings; and summary information about the qualifications and experience of the IOOF Research Team please visit https://www.ioof.com.au/adviser/investment_funds/ioof_advice_research_process.