Investing can be very unpredictable when it comes to balancing risk and reward. The value of your investments can change from day to day, or in some cases minute to minute.
But there are ways to predict how the value of a share might change. Many investors look to keep up the date with company reports, leadership changes and innovations.
However, as a Local Government Super (LGS) fact sheet explains, to determine the value of an investment is the ratio of buyers to sellers.
If it’s a “good” day then there will be more people wanting to buy than sell, and vice versa, if it’s a “bad” day there will be very few people interested in buying into the investment.
What is dollar cost averaging?
Dollar cost averaging (DCA) is the process of investing equal amounts of money in a particular investment at regular intervals.
For instance, you could decide to put $100 out of every paycheck into your ETF holding or managed fund account.
“It’s a way of averaging out the price of buying shares rather than worrying if it’s a ‘bad’ or ‘good’ day and not getting as much as you can out of your investment,” LGS said.
“When you spread your investment across multiple days, weeks, months or years, chances are some of them will be good and others will be bad, and you will average a higher return than you would if you invested all of your money on one particular day.”
DCA can work to take some risk out of the pricing of an investment and is mostly used by investors who are looking to be on the more conservative side.
Difference between DCA and lump sum
Placing a large amount of money into one investment can be risky, because if it turns out to be a bad day you could cop a significant loss.
“For the many Australians who do not study market trends and who want to incur as little risk as possible when saving for retirement, DCA is a great route to take,” LGS said.
“It’s an especially excellent strategy when you start early. By beginning to invest sooner rather than later, you lengthen the time period over which you invest in a particular investment.”
Vanguard senior personal finance writer Tony Kaye said that by allocating set amounts towards an investment, even with varying returns, you likely won’t do too badly over the course of time.
However, just because an investor takes the DCA route does not guarantee success.
“The use of dollar-cost averaging does not necessarily mean investments will succeed, and nor does it protect investors from falling asset prices,” Kaye said.
However, there is a definite value in countering the emotion normally associated with investing by adopting a DCA approach so long as it’s based on the general principles of diversification, he added.
“Dollar-cost averaging provides a straightforward way for most investors to steadily accumulate wealth without being overly concerned by prevailing market volatility,” he said.
“For those with long-term horizons with the discipline and resolve to keep investing, even during the most volatile investment periods as we’ve been experiencing, it’s a strategy worth exploring.”