Dollar Cost Averaging: A Smart Investment Strategy

One of the most common questions I get is, "When is the best time to add some more money to my Mirror Fund or KiwiSaver investment?"

I often encounter clients who are uncertain about the best way to enter the market, especially when it seems volatile or unpredictable. One strategy I frequently recommend is dollar cost averaging (DCA). This method not only mitigates risk but also helps to cultivate a disciplined investment habit.

Let’s delve into what dollar cost averaging is, its benefits, and the key considerations when applying this strategy.

What is Dollar Cost Averaging?

Dollar cost averaging is an investment strategy where an investor divides the total amount to be invested across periodic purchases of a target asset. This could be into stocks, mutual funds, or any investment fund, aiming to reduce the impact of volatility on the overall purchase. Instead of investing a lump sum, you invest a fixed amount regularly, say monthly or quarterly, regardless of the asset’s price.

How Does Dollar Cost Averaging Work?

Let’s say you want to invest $12,000 in a particular mutual fund. Instead of investing the entire amount at once, you decide to invest $1,000 every month for a year. When the price of the fund is high, your $1,000 will buy fewer units. When the price is low, your $1,000 will buy more units. Over time, this strategy averages out the purchase price of the investment, reducing the risk of investing at an inopportune time.

Benefits of Dollar Cost Averaging

1. Reduces Emotional Investing:
By committing to invest a fixed amount regularly, you avoid the pitfalls of trying to time the market. Emotional decisions, often driven by market highs and lows, can lead to buying at peaks and selling at troughs, which DCA helps to circumvent.

2. Mitigates Market Volatility:
DCA smooths out the effects of market volatility. By investing regularly, you are buying more shares when prices are low and fewer when prices are high, which can potentially lower the average cost per share over time.

3. Builds Disciplined Investment Habits:
Regular investing encourages a disciplined approach. It fosters the habit of saving and investing consistently, which is crucial for long-term wealth accumulation.

4. Accessible for All Investors:
You don’t need a large sum of money to start investing. DCA allows individuals to start with smaller amounts, making it an ideal strategy for new investors or those with limited capital.

Considerations When Using Dollar Cost Averaging

1. Long-Term Commitment:
DCA is most effective over the long term. Short-term fluctuations can be smoothed out, but the strategy relies on the market’s long-term upward trend.

2. Regular Review:
While DCA reduces the need for constant market monitoring, it is still important to periodically review your investment strategy and adjust as necessary. Ensure that the investment fund you choose aligns with your financial goals and risk tolerance.

3. Transaction Costs:
Be aware of transaction fees or charges associated with regular investing. These costs can add up and potentially eat into your returns. Many funds offer plans with reduced fees for regular contributions.

4. Market Conditions:
While DCA mitigates the risk of investing a lump sum at a market peak, it doesn’t eliminate risk entirely. It’s important to remain aware of broader economic and market conditions that could impact your investments.

In conclusion, dollar cost averaging is a powerful strategy for both novice and seasoned investors. By investing regularly and systematically, you can reduce risk, build disciplined habits, and potentially enhance your long-term returns.

​If you have any questions about how to implement DCA or which funds might be suitable for your financial goals, feel free to reach out. As always, I’m here to help you navigate your investment journey with confidence and clarity.

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Paul de Klerk