Dollar-cost averaging is a wealth-building strategy that involves investing money at regular intervals over a sustained period. It is a smart investment technique employed by investors worldwide. This is the opposite of simply investing a lump sum all at one time. Rather than trying to time the market, you buy in at a range of different price points.
If you’re a KiwiSaver member and you contribute to your account regularly through payroll, you're already practicing dollar-cost averaging.
In the long run, this is a highly strategic way to invest.
All investments rise and fall over time – this is inevitable and is referred to as market volatility. The volatility associated with investment markets is one of the major reasons some investors have been reluctant to invest in the past. However, if you follow the practice of ‘dollar-cost averaging’, the volatility risk can be diminished.
Also, as most investment markets have recently fallen in value, anyone who’s currently investing regular sums of any size is now buying the same underlying investment assets at a discounted price. One of the most successful investors in the world put it this way:
“A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.” – Warren Buffet
So, while it might feel uncomfortable to see a KiwiSaver balance drop, just remember, over the long run this is surely going to work out in your favour!
Dollar-cost averaging can also be used outside of KiwiSaver, such as with managed funds or by an individual investor purchasing shares.
This commonly suits many people building wealth for retirement who are still earning; for example, people with a regular fortnightly or monthly surplus from their salary or wages. You're not trying to time the market - you're simply investing a little bit over time to try to build value. Dollar-cost averaging lets you do it as your cashflow allows.
Making this strategy work does require a little discipline, as you need to keep investing a regular amount regardless of the ups and downs of the market. You need to keep your investment going through bad and good times to see the real value of dollar-cost averaging.
At some point in your life, you may have a lump sum to invest – perhaps as a result of the sale of a property or business, or perhaps an inheritance. In this case, you’re statistically better off investing it all at once. Numerous studies have proven that this is the case, with one famous study across three different major investment markets (the US, the UK, and Australia) from global investment powerhouse Vanguard stating “Finance theory and historical evidence suggest that the best way to invest this sum is all at once according to an investor’s asset allocation.” In each market that Vanguard studied, immediate investment led to greater portfolio values nearly 70% of the time. This comes down to two basic reasons:
For anyone who still chooses the dollar-cost averaging approach for a lump sum, a disciplined approach is best. This needs to be based on two key decisions:
This should ensure that cash is steadily invested while limiting the time the balance sits on the side-lines.
Through dollar-cost averaging, the current low prices for most investments suits those making regular contributions and will help them accumulate wealth over several years.
Dollar-cost averaging also:
To discuss this or any other investing approach, please get in touch.