When should I add money to my investments?
The simple answer is that as an investor it makes sense to buy when assets are cheap, and sell when they are expensive. But plenty of investors buy when news is good and investments are expensive – then sell when the news is bad, and investments have fallen in value. It’s a recipe for financial ruin.
I hear a lot of talk about how important it is to aim for ‘good market timing’. That means buying at the bottom of the market and selling at the top. And yes, wouldn’t it be great if we could all achieve this 100 per cent of the time? However, no market timers I know consistently get their timing right year after year. That’s because no one has yet worked out how to read the future.
The following table helps illustrate the difficulties of trying to consistently pick the ‘right’ market to invest in year in, year out. Over the last seven years for instance, US shares have dished up some impressive returns. But if we look to the last 20 years, Australian shares have topped the league table, with returns averaging 8.6% annually according to Vanguard data.
|Top performing asset class||Australian Property||Australian Property||International Shares||US Shares||US Shares||US Shares||International Property|
Now, you could be clever – or lucky – enough to pick the top performing markets every year. But I’d say the odds of pulling off such a staggering feat are about nil. Equally, your chances of picking the worst performing investments are also pretty slim.
The point is, if you try to add money to your investments at the right time, you need to be spot on with your investment timing decisions a lot of the time. And that’s just too difficult.
A far easier strategy is to invest when you have the funds available, and this is where dollar cost averaging can be so helpful. All you do is decide how much and how often you are going to invest. You may decide to invest monthly, quarterly or every six months. The timeframe really doesn’t matter because over time you will end up paying more of an average price for your investments, which helps smooth returns.
The key issue is that dollar cost averaging eliminates worries over when you should invest – a concern that can see people procrastinate to the point of never investing at all.
The beauty of dollar cost averaging is that it forces us to buy more when investments are cheapest and the least when asset markets are most expensive. On that basis alone, it can be a discipline worth using if you’re being hamstrung by uncertainty over when to add money to your investments.
Paul Clitheroe is Chairman of InvestSMART, Chair of the Ecstra Foundation and chief commentator for Money Magazine.