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Investing basics: should investors bulk-buy or drip-feed?

Emma Rapaport  |  05 Jul 2019Text size  Decrease  Increase  |  
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With the Australian share market climbing to just under its 11-year peak this week, and the economy slowing to its lowest rate in more than five years, investors sitting in cash are starting to ask: should I wait for the "market to crash" before I invest?

This investment strategy is often called 'timing the market' – where investors try to beat the market by switching in and out of securities or between types of funds.

We here at Morningstar are not keen on market-timing. Evidence suggests that it just doesn't work. Predicting market movements is near impossible, even for the best and brightest investors.

And other professionals agree.

"My view on timing the market is pretty simple. Nobody really knows if the market is going up or down tomorrow, next week, or next year," Stockspot chief executive Chris Brycki told the audience at last week's ASX Investor Conference.

"If they really did know, they wouldn't be telling you, they'd be sitting on an island enjoying a cocktail."

This is further proven by various studies from Morningstar, which indicate many stock investors buy stocks when the market is ready to dip, and sell when its performance is ready to pick up. And even if you correctly judge your exit from the market, this doesn't guarantee you'll get back in at the right time.

If market-timing is a losing strategy, what strategy should you take to deploy your cash? 

In this article we'll discuss the following methods:

  1. investing all at once, or lump-sum investing; and
  2. dollar-cost-averaging

Lump-sum investing

Some advisers recommend this approach above the others because the market climbs more often than it drops.

Let's look at an example:

Two people decide to invest $10,000 in XY Company – person A decides to invest the full amount in one hit, while person B invests the same amount in five monthly tranches of $2,000.

The stock consistently rises in value during that time. The table below illustrates what would happen to the two investments.

Investing in company XY: Stock rising

Dollar cost average 1

Person A would end up ahead, because they own more shares at the end of the five-month period than person B. This is because the consistently rising value of the stock meant person B couldn't afford to purchase as many shares as person A purchased originally.

But what happens if the value of the stock fluctuates dramatically during those five months?

Investing in company XY: Stock fluctuating

Dollar cost average 2

In this case, person B ends up ahead. By investing a fixed dollar amount in the fund every month, Person B bought more shares when the price was low, fewer shares when the price was high, and ended up with more shares after five months.

Dollar cost averaging

Investing in dribs and drabs may not be the path to greater return, but Morningstar still thinks dollar-cost averaging, a favourite practice of "the father of value investing" Benjamin Graham, is a great method of investing.

For dollar-cost averaging, you simply invest the same amount of money every week, month, or salary payment interval.

Morningstar's argument for dollar-cost averaging has three dimensions.

First, dollar-cost averaging can reduce risk. If your investment declines in value, the worth of your investment is less, even though you still own the same number of shares.

In the same way that dollar-cost averaging will net you more shares in a declining market, it can curtail your losses as the investment goes down. The table below illustrates this point.

Investing in company XY: Stock in decline

Dollar cost average 3

In this example, both person A and person B lost money – remember, they each started with $10,000 – but person B lost less by dollar-cost averaging. They had cash sitting on the sidelines that did not lose value. And when the fund rebounds, they also will be in better shape because they own more shares of the fund than person A does.

A second advantage of dollar-cost averaging is that it instils discipline. Investors often chase past returns, buying funds after a hot streak of performance, and selling when returns slow or decline. This is a bad idea, because it's a form of market-timing.

Dollar-cost averaging prevents you from market-timing, because you're buying all the time. You may even forget that you're investing if you set up an automatic-investment plan with a fund.

Lastly, dollar-cost averaging is a great way to invest in funds.

Many funds will lower their minimum investment requirement after you meet the minimum initial investment if you set up an automatic-investment plan that invests a fixed amount each month.

For example, the Vanguard Index Australian Shares fund (5397) has an initial minimum investment amount of $5,000, and an additional minimum investment amount of $100 (BPAY).

Which strategy is best for you?

While market-timing is out of the question for investors (but some still try), which investing strategy wins out? Buy now and invest a lump sum, or average out your investments overtime?

Morningstar says whether you invest all at once or a little at a time depends on how much time you have to invest and whether your primary goal is maximising return or minimising risk.

The shorter your time horizon, the greater chance you take of losing money with a lump-sum investment. However, if you had $20,000 to invest, it probably wouldn't make much sense to invest $1,000 per year for the next 20 years.

Morningstar suggests combining the two strategies: invest as much as you can today and vow to invest a little more each month or quarter. That'll keep you disciplined and have you investing right away.

Robin Bowerman, principal, market strategy and communications at Vanguard Australia, says there are pros and cons to using dollar-cost averaging.

“It certainly can be a valid technique, but if you accept that markets generally go up over the long-term, the earlier you invest, the better off you will likely be over the long-term by taking full advantage of any rise in share prices," he told Morningstar contributor Nicki Bourlioufas.

“A Vanguard research paper found that, given certain assumptions, investing a big lump sum all at once had a better chance of producing higher long-term returns than drip-feeding the money into the market using dollar-cost averaging."

This finding was based on historic long-term returns from a combination of shares and bonds in Australia, the US and the UK.

However, Bowerman highlights another behavioural benefit of dollar-cost averaging, in helping to remove emotion from the investing process.

“For most investors without a huge windfall to invest, a critical role of dollar-cost averaging is to help keep us focused on the long-term in a disciplined, non-emotional way. It is one of investment's emotional circuit breakers,” he says.

If people receive a lump sum, whether an inheritance, employment payout or someone rolling over a large sum into a self-managed superannuation fund, dollar cost averaging spreads out investment risk, financial adviser Bruce Brammall says.

“The reason for dollar-cost averaging or investing over a period of time is to spread the risk out that you aren’t investing at the market peak," he told Bourlioufas.

A version of this article first appeared in the Morningstar Investing Classroom.

is a reporter for Morningstar.com.au

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