Dollar cost averaging is an alternative strategy to investing a lump sum. Using this approach you invest a set amount at regular intervals over time. This method of investing can be a powerful risk reduction strategy during times of market volatility or uncertainty, and can help you avoid the pitfalls of trying to choose the best time to invest.
Investor A: $200,000 lump sum investment with no dollar cost averaging
| month | unit price ($) | units purchased | value of investment ($) |
| 1 | 1.00 | 200,000 | 200,000 |
| 2 | 0.70 | 0 | 140,000 |
| 3 | 0.80 | 0 | 160,000 |
| 4 | 0.90 | 0 | 180,000 |
| 5 | 1.10 | 0 | 220,000 |
Investor A’s patience has been rewarded by an increase in the value of the initial investment.
Investor B: $200,000 invested over five months, at $40,000 per month dollar cost averaging
| month | unit price ($) | units purchased | value of investment ($) |
| 1 | 1.00 | 40,000 | 40,000 |
| 2 | 0.70 | 57,143 | 68,000 |
| 3 | 0.80 | 50,000 | 117,714 |
| 4 | 0.90 | 44,444 | 172,428 |
| 5 | 1.10 | 36,363 | 250,745 |
Investor B has a greater investment value at the end of the five months. By committing to a regular investment amount, despite the fluctuating price movements, Investor B was able to purchase some units in the managed investment at a reduced price. In fact, the average unit price that Investor B was able acquire units for was $0.88.
Lump Sum or Dollar Cost Averaging?
The principle of dollar cost averaging does not mean that investing a lump sum is not an appropriate strategy. If markets rise in value over a long period of time after you make your initial lump sum investment, this method can be advantageous.
However, if you are reluctant to commit a lump sum in an uncertain market, dollar cost averaging can help minimise the risk of timing your entry into the market. If you enter into a dollar cost averaging strategy it is important to view it as a risk minimisation strategy as opposed to a way of maximising returns.
