We’ve certainly seen first hand over the past 18 months the impact of volatility on investing.  Look at a chart of the performance of the All Ordinaries over that time frame and you’ll see so many mountains and valleys that you’d be forgiven for thinking you’re looking at an elevation map of the Himalayas!

Forget market timing
Correctly timing your entry into and out of the markets is the elusive Holy Grail of investment and virtually impossible to do repeatedly without a crystal ball.  There are hazards in trying to time your movements into and out of the markets.  Unless luck is on your side (or you really do have a crystal ball!), you’re likely to be out of the markets when you should be in and vice versa.  As they say, “you’ve got to be in it to win it” and be prepared to ride the inevitable ups and downs.  So what is the solution?

Dollar Cost Averaging
One of the principles of successful investing is to make regular contributions.  This way, you buy when asset prices are low, and you also buy when they’re high.  You don’t have to agonise over picking the right time in the marker, and best of all your buying price will be lower over the long term.  This concept is known as “dollar cost averaging”.  Dollar cost averaging is a very straightforward concept:  you decide to invest a set amount on a set schedult and you stick to it!  When you’re investing a little, and often, market timing becomes less relevant – you just keep on investing on the basis of the idea that being invested long term is better than not being invested.  Dollar cost averaging should be seen as a way to reduce risk for invetors who would usually be reluctant to invest over the long term due to market uncertainty.

An Example of Dollar Cost Averaging
Mary decides to use dollar cost averaging and wants to invest $250 on the last Friday of every month for 4 months into Australian shares.  Below is what happened after 4 months:

At the end of this period, Mary had purchased 979 shares for a total investment of $1000 with an average dollar cost per share of $1.02.  Because she was able to average out the price per share, it is likely that she ended up paying a lower average cost per share than if she had tried to pick the market timing and bought $1000 worth of shares at the one time.

Of course, dollar cost averaging isn’t suitable for everyone so it’s very important that if you’re interested in this strategy that you discuss it with a financial adviser experienced in dollar cost averaging.  For more information or to arrange your free first financial planning meeting to find out more, give us a call on 02 8238 0888.

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One Response to “Dollar Cost Averaging”

  1. Martin April 23, 2010 at 3:51 pm #

    So from reading this article it’s basically saying if you invest at the same time say every month or whenever you want that you’ll sometimes buy cheap, sometimes more expensive but the investment amount will average out right?

    So why doesn’t everyone do this instead of watching the stock market daily to try and time exactly when they should buy and sell? Surely Dollar Cost Averaging would be a far less risky way to invest in the share market??