Plenty of negatives with cost averaging

By MARY HOLM

I am puzzled by the term "negative dollar cost averaging" in one of the questions put to you recently.

It seems to me that the best strategy in withdrawing from a managed fund over a period of years would be to sell a fixed number of units each year.

With this method, the withdrawal from the fund would be large when the unit price is high and small when the unit price is low.

Summarising: when buying, use a fixed number of dollars per period.

When selling, use a fixed number of units per period. In both cases, a holding account may be required.

I would very much appreciate your comments.

Your maths is good. In practice, though, your thinking might not be as useful as it seems.

Dollar cost averaging happens when you invest the same amount into shares or a share fund regularly - perhaps monthly or quarterly.

With your given amount, you buy more shares or units when the price is low and fewer when it's high.

That means that the average price you pay is lower than the average market price over the period.

It's a big advantage of regular investing. And you don't have to worry about trying to time your purchases.

I hadn't heard of negative dollar cost averaging until the reader wrote about it a few weeks ago.

But I assume he meant regularly selling the same dollar amount of an investment.

Doing that is negative not just because you're selling instead of buying. It also means that you sell more when the price is low and fewer when it's high.

The average price you receive is lower than the average market price. It's clearly not a good strategy.

Your suggested alternative, selling a fixed number of units per period, regardless of their price, is potentially better. Your average price will be the market average.

The trouble is that usually, when you sell an investment, you want to get a specified amount of money - rather than whatever you can get from selling a specified number of units.

You might want to buy a particular item, or supplement your NZ Super with $2000 a month or rebalance your portfolio.

(Examples of rebalancing: you've decided that 60 per cent of your savings should be in share funds. But share funds have done well lately, and now account for 70 per cent of your savings. You will want to sell the correct dollar amount to get back to 60 per cent. Or you're retired and have put the money you'll use in the next eight years in bonds, and the longer-term money in shares. Each year or so, you need to move a specified amount from shares to bonds.)

On the other hand, people are sometimes flexible in their cash requirements.

You might sell a fixed number of units each year and, if the markets have done well, you go on a grand tour of Europe. If not, you rent a bach up north.

Or, as you suggest, you could use a holding account, putting some of your sales proceeds in term deposits in good years to boost your proceeds in bad years.

And it's good to build some flexibility into your rebalancing, so you can move more money when the market has done well.

Your idea of selling a fixed number of units would take care of that.

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