A powerful and straightforward investment concept known as dollar-cost averaging enables investors to potentially make higher sharemarket volatility work for them.
Dollar-cost averaging simply involves investing equal amounts of money into the market at regular intervals – regardless of whether share prices are up or down.
This means investors buy more shares or units in managed funds when prices are lower and fewer when prices are higher. In other words, the purchasing costs are averaged over the total period in which the investor keeps on investing.
Although dollar-cost averaging may potentially reduce the average price paid for stocks, its core attribute is that investors are encouraged to invest in a non-emotional, disciplined way throughout changing market conditions. This includes in the highly-volatile market we are now experiencing.
Significantly, dollar-cost averaging acts as an antidote against any temptation by an investor to become swayed by prevailing market sentiment and to end up following the investment herd. And typically the investment herd will sell after prices have fallen, only to buy back into the market after prices have risen.
In a recent commentary, Bill McNabb, chief executive of the Vanguard Group, wrote that by making regular, fixed-dollar investments following a dollar-cost averaging approach enables an investor to put the "market’s natural volatility to work for you".
He emphasises that this approach enables investors to keep buying during market dips at potentially lower average costs while remaining focussed on their long-term goals rather than getting caught up in the mood of the market.
Of course, dollar-cost averaging does not guarantee investments will make a profit, nor does it protect investors from falling share prices.
Burton Malkiel, a professor of economics at Princeton University and author of a true investment classic, A Random Walk Down Wall Street, ranks among the foremost advocates of dollar-cost-averaging.
In his best-selling book (now in its 10th edition), Malkiel, writes that the "timeless" technique of dollar-cost averaging can help investors address the reality that attempts to time the market are most unlikely to succeed consistently over time.
Rather than attempting to pick the best time to buy or sell shares, dollar-cost averaging, as discussed, involves buying throughout changing market conditions.
In Australia, super fund members having compulsory and/or voluntary contributions regularly paid into their super balanced accounts are, of course, practising a form of dollar-cost averaging.
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Robin Bowerman is Head of Market Strategy and Communication, Vanguard Australia. As a renowned market commentator and editor Robin has spent more than two decades writing about all things investment. |
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