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Dollar Cost Averaging

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. 

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