It's Christmas time! Is it raining monetary benefits for you? You might have recently received a huge sum of money, such as a profit from a sale, a business, or a property. Maybe you just received your bonus bonds payment, or an inheritance or you had a windfall.
A common question is- “How do I invest it for my future?”
Do you invest it all at once or in smaller increments over time, a strategy known as dollar-cost averaging?
Let us see what happens when you invest all at once
Traditionally, we have been told that investing all the money that we suddenly receive is a good idea. To look at the positives of investing all the money at the same time:
• You will gain good exposure to the markets as soon as possible
• Historical market trends indicate the returns of stocks and bonds exceed returns of cash investments and bonds
• When markets are going up, putting your money to work right away takes full advantage of market growth
• The dividends can provide a secondary income
If you go all in with a lump sum investment and then the market collapses, it could have a negative effect on your lifestyle for years to come. Might be good to note that if you choose to invest your windfall, it's important to think about the emotional side of investing, not just the numbers.
Now, what does dollar-cost averaging does to your money or in other words, what happens to your lump sum if you go slow and steady?
• Minimize the downside risk of a huge investment
• You can take advantage of the market's natural volatility by lowering the average price you pay for shares
• Avoid feelings of regret if the market takes a downturn after you invest
De-mystifying dollar-cost averaging
In very simple terms- dollar-cost averaging involves investing specific amounts of money at regular intervals, regardless of the price at the time. For example, if you have $10,000 you're able to invest, instead of buying $10,000 worth of managed investment funds at once, you may decide to break it down like the following:
Weekly: $10,000 / 52 weeks = $192.31 each purchase
Monthly: $10,000 / 12 months = $833.33 each purchase
Quarterly: $10,000 / 4 quarters = $2,500 each purchase
Another example, say you’re interested in buying some shares in a company. They might cost you $2.40 per share today, $2.50 next month, and $2.20 the month after that. If you invested $100 each month you’d have 127.12 shares with an average price of $2.36 per share.
If you purchase all $300 worth at today's price of $2.40, then I would only have 125 shares. Well, it might not sound a lot, but if we deduce that out over bigger amounts and over your whole investing life, it can add up quite quickly to a large amount of money. Not to mention the added stress of wondering whether you’ve just bought everything at the very top of the market (or sold everything at the bottom)!
Don’t try to time the market
“Time in the market is more important than timing the market" is an investment saying that has stood the test of time. Using dollar-cost averaging removes the temptation of trying to time the market -- which is extremely hard, to say the least -- and making irrational investment decisions. Nobody knows when the market will crash or drastically decline. Using dollar-cost averaging helps ensure you don't invest a lump sum right before a major market drop.
How does it work in KiwiSaver?
Every time a KiwiSaver member gets paid by salary or wages, the member normally contributes a minimum of 3% into their KiwiSaver account to be invested by their provider. When that money is invested, it is used to purchase units in the fund or combination of funds the member has selected.
Some months, market performance may be high, and the price of the units that a member purchase may be higher - so a regular contribution may not buy as many units. At times the market performance could be lower or negative and a regular contribution will buy more units.
When the market improves, the units purchased at lower cost will have earned more than those which were purchased at a higher price.
“Dollar-cost averaging” might sound complicated, but on the contrary, it is a simple system of investing that anyone can adopt. Additionally, its primary benefit is to take the guesswork and emotion out of investing and portfolio management.
Let us know how you found the article and your thoughts and concerns about lump-sum investment. Leave us a comment and one of our advisers will answer your question.
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