The power of dollar-cost averaging

 

How regular investments and compounding add up to higher long-term returns.  

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If you’re a member of a managed superannuation fund, chances are you’re already benefitting from the long-term power of dollar-cost averaging.

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But what exactly is it, and how does it work?

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Think of it this way. Each time your employer makes a contribution into your super fund account it’s automatically invested by your fund according to the investment strategy that you’ve chosen.

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That could be a balanced investment strategy, split evenly between shares and bonds, or perhaps you’ve opted to take on more risk by having a higher exposure to shares through a growth or high-growth strategy.

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Behind the scenes your super money is most likely being directed into different managed funds, which typically invest in shares, bonds, cash, and other types of assets.

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And here’s where the dollar-cost averaging part comes in.

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While the amount of super you’re paid by your employer doesn’t change, your investment purchasing power does every time you receive a super contribution.

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That’s because the prices of the assets you’re investing in change on a daily basis.

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If the prices of the managed fund units your super fund invests in have risen since your last contribution, then you’ll effectively be purchasing fewer units (indirectly through your super fund) than you did last time.

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Likewise, if the managed fund unit prices have fallen in value, you’ll be purchasing more units than the time before.

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The only thing that’s constant is your dollar investment amount.

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Dollar-cost averaging provides a straightforward way for most investors to steadily accumulate wealth without being overly concerned by prevailing market volatility.

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Forget timing markets

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Similar to a regular savings plan, dollar-cost averaging simply involves investing the same amount of money at set intervals over a long period – whether investment prices move up or down.

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Investors practising dollar-cost averaging automatically buy more assets when market prices are lower and fewer assets when prices are higher.

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Over the total period that you keep investing, your average entry cost into specific assets will potentially be lower than if you’d try to guess the best time to buy in.

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But the key benefit of dollar-cost averaging is not so much about the price you pay for securities each time.

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Just like your super contributions, it’s about you sticking to a disciplined, non-emotional approach to investing that’s not affected by what’s happening on financial markets at any particular point in time.

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It’s very useful in helping you to focus on your investment goals, ideally via an appropriately diversified portfolio, to give you the best chance of investment success over the long term.

 

Putting dollar-cost averaging into practice

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So, how does a dollar-cost averaging strategy, using a combination of regular contributions, reinvestments of distributions, and compounding investment returns, stack up over time?

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The table below is based on a starting amount of $1,000 and set fortnightly contributions over a 10-year period, with an average annual return of 6% including distributions.

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