Regular way to avoid a common trap

Dollar-cost averaging seems a less-than-edgy strategy but it helps ensure smoother returns

PUBLISHED : Monday, 04 March, 2013, 12:00am
UPDATED : Monday, 04 March, 2013, 4:08am

It's funny to think back to school when everyone told you to reach for the stars. On the other hand, financial advisers encourage investors to dollar-cost average. This means investing the same amount into a market, stock, or other kind of investment on a periodic basis instead of all at once - it's the way that the Mandatory Provident Fund works for most employees.

So why do many financial advisers recommend averaging in instead of investing all at once? Is there some kind of conspiracy? Are we supposed to forget all of the encouragement at school to dream big, and pump all our money at once into a sure-fire investing idea?

Human behaviour being what it is, we're tempted to spend any money laying around. The first and probably most important reason to average into investments is because it forces you to invest instead of waiting for something to become cheap.

Dollar-cost averaging also deflects investors from a common trap - the temptation to try to time markets. We all like to think we have special insight on where prices are headed and deploy strategies such as buying after a big sell-off but the reality is that if investing were this easy we'd all be retired living in our favourite resort.

If market professionals often misjudge whether something is cheap or attractive, how is Joe Sixpack supposed to figure it out? Furthermore, even if Mr Sixpack gets his valuation right, the markets often do not adhere to the best common sense - and, as the economists say, the markets can remain irrational longer than you can remain solvent.

In other words, while you're waiting and waiting for markets to prove you correct, you can no longer pay your mortgage because you decided to go all in upfront on a leveraged basis while your beautiful investment subsequently tanked. Or the opposite case, while you're waiting for the perfect time to invest the market suddenly runs up (think March 2009) and the train's left the station before you got on.

The beautiful thing about dollar-cost averaging is that you know at times you'll be buying when prices are relatively low and that will give you some satisfaction when you look at your statement and see that sometimes you bought when prices were high.

By averaging out your purchases you miss some of the upside and limit some of the downside. This should result in smoother returns. It's an easy way to manage share-price volatility, the most stressful part of investing in stocks and a big reason why people avoid them.

Robert Jones is head of FCL Advisory, which advises family offices and wealthy individuals