Dollar-cost averaging: a suspect plan?
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Nicki Bourlioufas is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind.
By following a simple practice known as dollar-cost averaging to buy shares or managed funds, it's claimed that investors can protect themselves against market downside risk.
The idea is that you regularly invest a certain amount of money into securities despite what the market is doing. It's claimed dollar-cost averaging spreads investment over an extended period of time; your focus becomes accumulating assets over time, rather than trying to time the market.
For example, a total of $100,000 could be divided into 10 equal amounts to invest over a year irrespective of how markets perform. In contrast, with lump-sum investing, an investment of $100,000 would be made at a single point in time.
So which investing strategy wins out?
Robin Bowerman, principal, market strategy and communications at Vanguard Australia, says it is doubtful whether dollar-cost averaging is more lucrative, and a study by Vanguard shows it generally isn't.
"The arguments against dollar-cost averaging are well made when you look at things rationally--and if you believe that over the long term markets will continue to go up, on that basis the best day to invest is today and let it run," he says.
This is backed by research from Vanguard that reveals that historically, lump-sum investing has a higher chance of outperforming dollar-cost averaging.
"The studies we have done at Vanguard show this has been the case in Australia, the UK and the US for both share and bond portfolios, and portfolios diversified across both asset classes," says Vanguard investment analyst Scott Pappas, who recently crunched the numbers.
"Lump sum investing has demonstrated a higher probability of outperforming dollar-cost averaging across a range of different markets and assets. Of course, this is no guarantee of future performance.
"While lump-sum investing may have a higher chance of outperforming dollar-cost averaging, it does not mean it will do so every time. In fact, it is likely to underperform during periods where markets are falling."
According to MLC Financial Planning, investors need to be aware that when market prices are trending upwards, a portfolio purchased upfront will do better than the portfolio purchased using dollar-cost averaging. This is because the full gain on the price rise is captured by the full amount of the initial investment.
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