• Trustees Private Wealth

Aug 31, 2022

Investing Explained Series: What is Dollar-Cost Averaging?

Financial literacy is something that everyone needs, but financial topics can often be misunderstood. To have the best chance of achieving your financial goals and building financial resilience, education is equally as important as action. At Trustees Executors, we continue to emphasise the importance of financial literacy to our clients and all New Zealanders. Our first article in this series was learning about Hedging, and this article will introduce a new topic.

Our second topic is Dollar Cost Averaging (DCA). Like hedging, DCA is a regular phrase used in financial markets. This article covers the core concepts of DCA and what type of investments typically involve this method of investing. 

What is dollar-cost averaging?

The concept behind dollar-cost averaging is straightforward: at regular periods, you invest the same sum of money in a certain investment. Investors do this to lower their risk of making a large investment in a single investment at an unfortunate time. For instance, you invest $100 in an investment every month, regardless of the price. A good example of dollar-cost averaging most of us already do is your KiwiSaver.  

As a result, you can use your allocated funds to purchase more of an investment when the price is lower. Additionally, you purchase less when the price is high. This makes the average price per share lower, which lowers your investment risk.

Different types of dollar-cost averaging investments 

There are several investment options you can choose from when using the DCA method, depending on your level of experience. 

Direct Shares

Shares are one of the most simple options for DCA.  A DCA approach may be used on several reliable blue-chip and mid-cap shares that are within various price ranges. Investment platforms allow you to automatically dollar-cost average by setting up recurring payments for certain shares. This strategy is easy to understand and to establish if you would like to try DCA.

Real estate investment trusts (REITs)

Shares of a combined portfolio of real estate assets make up REITs. This is a good option to participate in the real estate market with some volatility protection, especially through shares of publicly listed REITs. Additionally, they may be acquired through stock market transactions. You can use DCA to buy into REITs at regular intervals.

Exchange-traded Funds (ETFs)

ETFs have curated portfolios of shares and other financial instruments that are traded publicly. ETFs exist to serve various risk profiles and frequently mirror an underlying index, such as the NZX50 in New Zealand or the S&P500 in the US. Similar to shares, buying shares of an ETF using a dollar-cost averaging technique is a simple way to build a diversified portfolio with a rising position. Through ETFs, you can have entry-level access to invest in larger companies that have a proven track record of returns.

Unlisted Funds

These funds are ownership structures, often Portfolio Investment Entity (PIE) used to own a range of underlying assets. These assets can be one or a combination of asset classes such as Cash, Bonds (Fixed Interest), Listed or Unlisted Property, shares, commodities (eg: iron ore, gold) or other sub-sets of these. Most KiwiSaver funds are of this nature. Some are “multi-asset” funds while others are single asset funds. Some funds have an ‘active style’ whereby the manager seeks to pick assets with a view to beating an index. Other funds follow a ‘passive style’ where the manager sets and follows a set of rules for buying and selling that seeks to achieve returns that match a certain index. Unlisted Funds are not traded on an exchange but require an application to buy or sell. Costs of buying and selling are generally quite low for unlisted funds when compared to listed funds where some form of brokerage will be paid. These funds are ‘unitised’ where you buy or sell units, for which the value is normally established daily. You will buy and sell these units at the value of the underlying assets whereas with listed funds you may be buying at a value greater than the underlying assets or conversely at a value less than the underlying assets.

For example: 

Buy $100.00 of units at $1.00 a unit = 100 units. Value of holding = $100.00

Price of unit falls to $0.50. Buy $100.00 of units = 200 units. Total unit holding = 300. Total value of holding = $200.00

Price of unit rises to $1.00 a unit. Total value of holding goes to $300.00, for only $200.00 invested.

Final thoughts and reminders

When investing, it is always important to understand what you are investing in and how your investment strategy will support your financial goals. That often means not only becoming financially literate before you invest, but doing research into various industries, businesses, and financial instruments.

DCA is a good option if you are looking for an investment strategy that can adjust to market volatility. This article does not cover all aspects of DCA, and we encourage our clients to ask questions. If you would like to learn about how our advisers can help you understand more about investing, develop your own financial skills, manage your investments, or help you reach your financial goals, reach out to us today.

Recent blogs