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. Â
Investor A: $200,000 lump sum investment with no dollar cost averagingÂ
month | unit price ($) | units purchased | value of investment ($) |
1Â | 1.00Â | 200,000Â | 200,000Â |
2Â | 0.70Â | 0Â | 140,000Â |
3Â | 0.80Â | 0Â | 160,000Â |
4Â | 0.90Â | 0Â | 180,000Â |
5Â | 1.10Â | 0Â | 220,000Â |
Investor A’s patience has been rewarded by an increase in the value of the initial investment.Â
Investor B: $200,000 invested over five months, at $40,000 per month dollar cost averaging
month | unit price ($) | units purchased | value of investment ($) |
1Â | 1.00Â | 40,000Â | 40,000Â |
2Â | 0.70Â | 57,143Â | 68,000Â |
3Â | 0.80Â | 50,000Â | 117,714Â |
4Â | 0.90Â | 44,444Â | 172,428Â |
5Â | 1.10Â | 36,363Â | 250,745Â |
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.Â
Lump Sum or Dollar Cost Averaging?Â
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.Â
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.Â