This tutorial is short, sweet and simple.
Dollar-cost averaging is the strategy of adding money to your investments; rain, hail or shine.
You can, for example, automate your budgeting and invest $1,000 on the 2nd day of every month.
The ‘averaging’ part of dollar-cost averaging means you take advantage of low prices and high prices, so the result is the average.
| Month 1 | Month 2 | Month 3 | |
| ETF price | $10 | $8 | $12 |
| You invest | $1,000 | $1,000 | $1,000 |
| You get | 100 units | 120 units | 80 units |
| Average price: | $10 |
Average returns, extraordinary results
If you commit to dollar-cost averaging, you might think that you’re not doing anything spectacular. And you’re not… at first.
I believe dollar-cost averaging works especially well when you’re a long-term ETF investor because you take advantage of gradual growth in financial markets and it forces you to invest – no matter what the commentators, your uncle, brother-in-law or Twitter say.
If you look at almost any chart of the Australian or US sharemarket over 20 years or more, I reckon you will notice it goes from bottom-left to top-right.
It won’t be a straight line. Share markets rise and fall from time-to-time. And it can be scary.
HOWEVER…
Over the ultra-long-term (30+ years), shares almost always perform better than most other types of investments, such as term deposits. The #1 problem affecting investors’ returns from shares is themselves.
Let me explain. Many people think ‘stocks are like gambling’ – and so they treat it that way. They pick random investments based on weird trading patterns or get greedy after reading something in a Facebook group.
A lot of people simply don’t understand what they’re investing in. I’ve told my in-laws to invest in ETFs for years — and they still call them ‘EFTs’ (like EFTPOS!). As you’ll know, from our courses, podcasts and this website, an ETF invests in shares of a business, bonds are like owning debt, etc. They’re real things and the more you learn, the more you realise it’s not gambling and it’s not random.
Finally, I find that the main reason people are their worst enemies is because of their behaviour. They get scared when markets fall — which is the best time to invest – and they get greedy when markets rise too fast — the worst time to invest. They also fall into ‘predicting’ returns. How many times have you heard ‘the elections are this year, the market might fall’ or ‘I’ve heard that prices might fall this year because of the [insert number between 1 and a million] reasons’.
Proof it works
In 2013, Charles Schwab (a big US investment company) released a study of 5 hypothetical investors. The 5 investors received $2,000 at the beginning of every year between 1993 and 2012 (that’s 20 years). Each investor had their own strategy.
One of the investors had the perfect or 20/20 timing. He invested his $2,000 in the stock market on exactly the lowest day for the year – he couldn’t have timed it better. After 20 years he had $87,004.
The worst possible investor — ‘Rosie Rotten’ — did the exact opposite. Somehow, someway, she managed to invest her $2,000 on the highest day for that year. She ended up with $72,487 — a very good return considering her run of bad luck.
The next three investors were the investors that most surprised me.
One of the investors decided not to invest in shares and instead stayed in cash — basically 100% term deposits (in the US example it was 100% treasury bills). This ‘safe than sorry’ person had just $51,291 after 20 years — that’s despite having $40,000 to invest (20 years x $2,000 per year) and interest rates over 7%! Interest rates are now 0%.
Finally – most importantly – the investors who simply got their $2,000 on January 1st and invested it immediately and the investor who dollar-cost-averaged (invested his $2,000 in 12 monthly instalments) ended up $81,650 and $79,510, respectively.
In other words, they didn’t even THINK about ‘timing the market’, they just invested. And guess what: they were nearly as well off as the ‘perfect timer’. There was no worrying about what the market was doing, nor what the TV ‘expert’ said. There were no gold speculations, no debt involved and they never worried about how much they invested. They just… invested!
So easy, yet so powerful!
You want to know what’s even more powerful. They didn’t just do one test. Schwab’s Mark Riepe writes, “Actually, we looked at 68 separate 20-year periods in all, finding similar results across almost all time periods.”
If I were a lawyer debating market timing, this is when I’d say, “your Honour — I rest my case”.
Just remember this
By dollar-cost averaging (little bits, lots of times) you will set yourself up to take advantage of the potential long-term growth of share markets and, chances are, you will receive dividends from your investments along the way — which can then be reinvested back into more investments.
That’s simple, effective, dollar-cost averaging.
Accumulate. Just accumulate.
Or, if you automate — treat your monthly investing as if it were an electricity bill you have to pay.
