Ask An Adviser - What Is Dollar Cost Averaging?

Top answer provided by:

Matthew Timms

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Thanks Jake.

This is actually a commonly asked question.

Dollar Cost Averaging is where you spread out the purchasing of your investment, as opposed to purchasing all the asset at once.

It is also surprisingly common. Our superannuation contribution system is one such contribution system where your employer contributes to your superannuation on your behalf on a minimum of a quarterly basis for your working life. In doing this you are investing through all sorts of business cycles.

Another common example is employee share plans, as you have no control over the price or timing, you just continue to accumulate them over time.

So, what are the advantages?

Dollar Cost Averaging can help avoid a massive loss in investment value. For example, if there were to be a sudden correction after you invested, instead of losing 20% off your total portfolio, you may have only invested 10% of your money so far, which means you’ve only lost 2% of your total portfolio and will now continue to purchase at the reduced rate.

This is called the Recovery Scenario (see Figure 1), where we see a fall in value and recover over time (just like when COVID hit, though it was an asymmetric recover).

As the market fell, we increased our buying power with the Dollar Cost Averaging strategy and were able to purchase more units for the same amount of money. This helped to generate a better return than investing all at once.

Figure 1 - Recovery Market



Source: AMP Dollar Cost Averaging Calculator

But let’s look at a more common scenario.

The rising market. In Figure 2, we see that because the market has grown over the period, we had less purchasing power with the Dollar Cost Averaging strategy vs investing all available money at the start. Here, Dollar Cost Averaging smoothed the returns; however, this led to less overall growth.

Figure 2 - Rising Market



Source: AMP Dollar Cost Averaging Calculator

And finally, the sideways market.

A sideways market, traditionally full of small peaks and troughs, can sometimes help the Dollar Cost Averaging strategy to outperform the single upfront investment option. Again, you can see the Dollar Cost Averaging strategy has allowed you to purchase dips in the market price, allowing you to accumulate more assets over time.

Figure 3 - Variable Market



Source: AMP Dollar Cost Averaging Calculator

Final word.

You need to find the way that works best for you when investing. If you have a lump sum of money, you need to ask yourself if you would be happy to invest it all now, and won’t touch it if it falls 20%. Similarly, if you went down the DCA approach, would you maintain the strategy even when the market was down? Often we see people wanting to stop their investments when the market is falling, but it is the best time to invest.

And finally, time in the market vs timing the market. Time in the market almost always trumps timing the market as over the space of a few years the market is always returning to positive. Dollar Cost Averaging is a form of timing the market.

While the Adviser Ratings Website facilitates the question and answer functionality, all such communications are between users and authorised financial advisers, of which Adviser Ratings has no affiliation. Adviser Ratings is not the advice provider and does not provide financial product advice and only provides information that is general in nature.

Article by:

Matthew Timms

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