The fable we all learned as children has come back to teach us a valuable lesson in the current financial crisis.
If we could always 'buy low, sell high' we’d all have plenty of money for retirement. But it’s easier said than done. You’d need to be able to time the market – by predicting the market’s highs and lows. But in reality, no one can predict the exact turning points of the market.
A more workable strategy, based on the same ideal, is a trick of the trade called 'dollar cost averaging'. Perhaps the best thing about dollar cost averaging is that it’s a technique that eliminates the emotion from your investing and helps you invest more efficiently.
Is it hard to do?
To dollar cost average all you need to do is invest a consistent dollar amount into your portfolio regularly. This is automatically happening through your employer contributions and can just as easily be done by making your own personal contributions every fortnight or month. This way, you’re investing systematically – regardless of whatever the markets are doing at that moment.
How it works
When you contribute to a particular investment option, you generally buy units in that option. Remember, you’re investing the same dollar amount at regular intervals. So when market prices are falling, you automatically buy more units. When prices start to rise, you automatically buy fewer units. Over the long-run, the unit costs average out – hence the name!
...it's a technique that eliminates the emotion from your investing and helps you invest more efficiently.
Dollar cost averaging - slow and steady
Anyone who benefits from regular employer and voluntary superannuation contributions is already using dollar cost averaging. However, those with a lump sum to invest have a choice; putting all of their money in at once – or spreading the investment over a longer period.
What was the impact of Alice's lump sum investment versus Bob's regular contributions after one year? See it in action
You might think of it just like Aesop’s tortoise-and-the-hare. The lump sum investor – with one big sprint hoping for spectacular gain is the hare – versus the dollar cost averaging tortoise, investing steady amounts, slowly over time. It may not be the most exciting way to invest, but in an uncertain market, it is a long-term approach well worth considering.
When it's most valuable
Dollar cost averaging is a great long-term strategy and while it won’t guarantee you a profit, it will make the journey to reaching goals such as retirement a lot smoother by reducing the amount of risk along the way.
A commitment to dollar cost averaging also reduces the odds that you will invest a large sum when the cost of entering the market is higher. For this reason, it’s especially valuable for lump sum contributions in times of market uncertainty.
Make it work for you
- Remember you could already be using this strategy
- Stick to your long-term investment plan
- Continue to make regular contributions
- Take your time.