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W & K

Dollar Cost Averaging

Dollar cost averaging is something that seems to get talked about when investors are looking at making their first foray into higher risk assets such as shares. In our many years of experience, investors seek our advice when they have either accumulated significant savings which are invariably held at the bank, or when they have had an inheritance or have sold a business, often a farm.

Dollar cost averaging (DCA) is simply staggering a purchase of assets over time, typically when investing new money. Despite a lot of hype surrounding DCA, our experience and that of our asset allocation consultants suggests that DCA costs dollars on average. This is because it increases the amount of time spent invested in cash, which tends to be the lowest returning asset in the long term.

When markets are going up it costs investors. When markets are going down it is of benefit to investors. Anyone contributing to KiwiSaver on a regular basis through the workspace schemes are effectively dollar cost averaging. The difference is that KiwiSaver investors do not tend to have plenty of cash or term deposits available to invest as lump sums.

It does not make sense to dollar cost average when markets are fully priced that is when they are expected to return less than 2.5% per annum above government bonds. However, DCA doesn’t cost much and may help ease an investors’ anxiety especially when investing into asset classes they have never historically directly invested in. In this situation the DCA program should be relatively short term, probably more than six months is our suggestion.

When markets are overpriced, that is when expected returns are less than government bonds, DCA is not a bad idea. A better idea is not to buy expensive assets, just for the sake of becoming fully invested.

When markets are at fair value (returning 2.5% to 5% per annum above government bonds) DCA is very costly and totally unnecessary.  It’s much better to invest immediately.

When markets are cheap and in particular, cheap and falling, DCA really comes into its own. In these market conditions it will probably make money as well as relieving anxiety. This can be critical at this time for new investors. We all hate seeing portfolios go down in value, especially newly established portfolios. Even in these market conditions it can pay to keep the program fairly short, ideally a six month period, but no longer than 12 months.

New portfolio investors tend to lag behind the investment cycle. This is purely a human trait. They will have experienced good investment news on the media, and then decided it is time to invest.
Steven Barton (FSP 32663) and Susan Pascoe Barton (FSP 32382) are Certified Financial Planners and Authorised Financial Advisers.  Their initial disclosure statements are available free of charge by contacting them on (07) 3060080 or they can be downloaded from www.pascoebarton.co.nz. This column is general in nature and should not be regarded as personalised investment advice.