For clients looking to accumulate funds in a growth portfolio using a regular savings plan, many Financial Planners will recommend they use a strategy commonly known as dollar cost averaging.
How does Dollar Cost Averaging work?
Share markets, as an example, exhibit volatility. That is, the value of particular share, or the market in general, may increase, or decrease in value over the course of a day, week, month, year etc. However, history shows that over the longer term, the market in general rises. Therefore, if you are buying units in a managed investment, in a period where the prices are depressed, you will get more units for your money. When the markets are rising, you will accumulate fewer units. The result over the longer term should be a capital gain above the average unit price of the investment.
Beware of the Reverse – Dollar Cost Ravaging
Dollar cost averaging is fine for the accumulators. However, for retirees and others drawing a regular income from their managed investments, they run the real risk of “Dollar Cost Ravaging”.
What is Dollar Cost Ravaging?
With Managed Funds the value of the investment is calculated by a unit price. That price can fluctuate up and down with market volatility. If you are drawing down a regular payment, you may be at the mercy of the markets. If markets are depressed, particularly for a significant time, such as the GFC, you will be withdrawing more units to meet your payment and you will not get those units back. You are in fact, crystallising a potential loss. As such, you would suffer a loss of capital and the ability to meet future payments.
The Solution
The best way to insulate yourself from the “ravaging” is to have a portfolio that produces a regular income stream to meet your income payments, in such a way that you are not reliant upon drawing down on capital. Generally, this is best achieved by using direct shares that generate a regular constant income stream and staying away from
managed funds.
General Advice Warning:
The information provided in this document is general information only and does not constitute personal advice. It has been prepared without taking into account any of your individual objectives, financial solutions or needs. Before acting on this information you should consider its appropriateness, having regard to your own objectives, financial situation and needs. You should read the relevant Product Disclosure Statements and seek personal advice from a qualified financial adviser
