How it works is that you invest the same amount of money every month whether the market is up or down. It takes away the need to make judgments on whether it's a good time to buy or not. If the prices are low you get more investment for your money. If they're high, you get less, but over time you average out your investment.
Anyone who is contributing monthly to KiwiSaver does dollar cost averaging without even knowing it. Every month's contribution to KiwiSaver buys a different number of units at the current price.
When people talk about dollar cost investing they're usually referring to shares, managed funds and now KiwiSaver. You might also employ dollar cost averaging when buying gold, bitcoins or any volatile investment. Spreading out the purchase can take some of the market risk away.
A couple of years ago I sold a single gold coin on Trade Me. It had been donated to a fundraiser and we decided we'd make a better return at a public auction than on a white elephant stall. The buyer was a somewhat paranoid Russian who told me, when he came to pick his coin up, that he was stockpiling gold because he was convinced the world economy was going to crash and burn. He was effectively dollar cost averaging with gold. Every time he had a little money to spare - usually less than $100 - he'd look for a small piece of gold and buy at the market price that week. I just hope he has the gold stored somewhere safe.
Throughout an investment cycle there will be times when drip feeding investments is more profitable and times when it is less profitable. When the markets have overshot, then you get fewer shares or units for your money. When markets are priced in the middle you get an average return and when they're cheap you get your best return.
Thus a bad year for KiwiSaver or other investment returns can actually be a good thing. Thanks to dollar cost averaging you're buying more for your money in those years when capital gains are poor or negative.
The irony is that investors tend to be most anxious when prices are down, not up. They want to sell when the markets have just taken a tumble, whereas it is the perfect time to buy.
This is where the dollar cost average crowd cash in. They're buying when others are taking money out.
Morningstar's manager of research, Tim Murphy, says investors often take their money out when the fund is at the very bottom. This happened in 2009 and again in 2012-13. The company's United States research team found that this meant over a 10-year period when the average fund had returned 7.3 per cent, investors had gained only 4.8 per cent.
People who buy with the drip-feed approach have been shown by studies to be less likely to sell when markets crash. This reduces the human risk, not just the market risk.
There aren't an unlimited number of options for drip feeding money into shares and managed fund units in New Zealand. Anyone can buy a regular number of shares each month, but the ticket will be clipped by brokerage fees, which takes the edge off growth.
Some managed funds such as Fisher Funds and BT Funds offer regular savings plans that allow you to buy small numbers of units each month.
Smartshares funds, which most people buy through a broker, can be bought direct with no upfront fee by signing up for a regular savings plan. That's a good deal.
People who have signed up to the plan invest from $50 a month into their chosen fund. Smartshares sells five New Zealand and Australian index tracking funds, and a couple of new ones are on the drawing board. One will invest in commercial property and the other in global shares.
Some grandparents, says Smartshares head Sam Stanley, set up regular savings plans in their grandchildren's names. They prefer to contribute money straight into a share-based investment for the educational values it will give their grandchildren.
RaboDirect has a Regular Investor Plan, which allows investors to drip feed amounts of money into any of its more than 40 funds. The minimum investment is $250 a month.
The nice thing about RaboDirect's offering is that the 0.75 per cent upfront fee is reduced to 0.50 per cent for regular deposits.
If you wanted to invest a lump sum of, say, $10,000 in one of the funds on the RaboDirect platform you'd save $25 in fees by drip feeding it in at $1000 a month. It's roughly the same amount of paperwork either way.
Over the past three years, the monthly average amount invested by regular investment is about 12 per cent of the overall monthly amount invested in managed funds with RaboDirect, says key accounts and investment manager Michael Courtney.
There are many and varied tax implications of drip feeding money into investments, says Greg Thompson, national director of tax at Grant Thornton.
"It depends on the type of investment - [whether it is] direct or indirect, whether they are domestic or international, Australia or other, and whether they are bought on capital or revenue account."
Buy and hold investors in New Zealand and Australian investments are buying on "capital account" and are usually okay - meaning they're not hit with any complex tax calculations. But investors classed as traders (revenue account) pay what is effectively capital gains tax.
That can be difficult to calculate when they have regular small amounts invested at different periods in the year.
"If I buy 200 Spark shares this month and 200 Spark shares next month, and then in two years sell 50 Spark shares, which ones have I sold?" says Thompson.
People who drip feed money into overseas investments outside Australasia have to pay Foreign Investment Fund capital gains tax and will also have additional administration to do.
As with any investing strategy, dollar cost averaging has its downside. You can end up paying more in upfront fees if you buy shares every month. People who choose to drip feed money into investments usually find ones such as those above where there is no upfront fee, or at least the fee is a straight percentage so it makes no difference whether you invest a little or a lot.
Another argument is that the reduced market risk theory is a myth and that you could repeatedly be investing in the wrong investment, or investing in one that goes up and up and up. Had it been a one-off investment you might have happily paid $1.25 for all of your shares or units, but not $1.35 or $1.55 as the capital value rises. On the other hand, if you don't have lumps of cash to invest, you might not have bought all of your investment at $1.25 anyway.
There is no reason why you can't do both. Drip feed a regular amount every month as well as making one-off investments.
