What is dollar cost averaging?

Dollar cost averaging is a simple concept which helps to reduce risk by investing regularly to capitalise on purchasing when the market is down.

By investing a set amount at regular intervals, regardless of the unit price of your investment, more units are purchased when prices are low and less units when prices are high.

Dollar cost averaging doesn’t guarantee profit but, over time, should help even out market fluctuations.

How does dollar cost averaging work?

To better understand dollar cost averaging, use the example below:

Regular investment

You invest $200 a month into a managed fund that has an initial unit price of $10.

Your initial investment of $200 buys you 20 units.

Market fluctuations

During the next 12 months, the market drops a number of times, causing the unit price to fall to $5 for three months of that year.

The unit price finishes the year at its original price of $10.

You continue to invest $200 a month throughout the year. During the three months when the unit price dropped, you bought 40 units per month because the price had reduced.

One year after initial investment

Because the unit price dropped for three months you now have 300 units, each worth $10 and a total of $3000.

You have invested $2400, but your investment is now worth $3000 so your profit is $600 over 12 months, even though the unit price is the now the same as when you made your first month’s investment.