Many investors try to ‘time’ their investment in the market. That is, their objective is to invest in the property market or the share market when they believe that the market has hit its lowest point in the investment cycle.
Having assisted with the preparation of many tax returns, and providing financial planning and taxation advice, one thing is certain, a client never overestimates their income and understates their expenses. Almost all taxpayers do not want to pay a cent more tax than they are legally obliged to pay, and nor should they have to.
Most people that are financially secure have achieved that financial position from their investment strategies. The vast majority of these investors have accumulated their wealth over an extended period of time by investing in property and shares. They have not attempted to pick the low point in the market as even most experts and leading economists do not get this right.
You may remember in the mid to late 1990s that most property experts predicted that the property market would peak in 2000. Their reason for this was that they believed that there was excess construction in preparation for the Sydney Olympics and the introduction of the GST on new property would have a negative impact on property prices, particularly in Sydney. We know now that property prices continued to rise for at least another three years. I know of an individual that sold his home on the lower North Shore of Sydney after reading these so called ‘expert predictions’ only to find he could not buy back into the market until some years later.
So, how can you utilise the benefit of investing over an extended period of time as opposed to trying to ‘pick the market’?
Dollar Cost Averaging
Instead of trying to ‘time the market’, you may be better off ‘dollar cost averaging’. ‘Dollar cost averaging’ is an investment approach where you invest the same amount of money on a regular basis, usually monthly, into a share investment. It takes advantage of the only certainty of the share market – prices will continue to rise and fall.
Dollar cost averaging is a convenient and flexible way for investors to gain additional exposure to investments over time. The benefit of this strategy is that it reduces the risk of investing a large amount of money in a single investment at the wrong time.
By spending a fixed amount at set intervals, you are smoothing the ups and downs of the share market. Your fixed amount will buy more units or shares when the prices are low and fewer units or shares when the prices are high. This means the average price paid can be lower than the average market price.
A Regular Investment Plan
A regular investment plan is a disciplined method of investing and also an excellent way to benefit from dollar cost averaging. With a regular investment plan, a set amount of money is automatically debited from your bank account each fortnight or month.
You could use an investment plan to save for objectives such as your children’s educations, a holiday, a new car or for your retirement.
Example
John establishes a dollar cost averaging plan. He invests $1,000 per month in BHP, a listed Australian company, for 12 months (column A).
John’s regular investment is made at the same time each month. Each month, the market price of BHP varies in line with the daily stock market fluctuations (column B).
This affects the number of shares that John received for his $1,000 investment each month (column C).
|
A |
B |
C |
|
Regular Monthly Investment |
Market Price of BHP Shares each month |
No. of BHP shares received each month |
|
$ 1,000.00 |
$ 28.83 |
35 |
|
$ 1,000.00 |
$ 31.91 |
31 |
|
$ 1,000.00 |
$ 33.27 |
30 |
|
$ 1,000.00 |
$ 34.66 |
29 |
|
$ 1,000.00 |
$ 34.72 |
29 |
|
$ 1,000.00 |
$ 37.85 |
26 |
|
$ 1,000.00 |
$ 36.80 |
27 |
|
$ 1,000.00 |
$ 37.73 |
27 |
|
$ 1,000.00 |
$ 37.45 |
27 |
|
$ 1,000.00 |
$ 41.30 |
24 |
|
$ 1,000.00 |
$ 43.12 |
23 |
|
$ 1,000.00 |
$ 39.40 |
25 |
|
Total $12,000.00 |
Total 333 |
|
Outcome
John has purchased 333 shares for $12,000 over 12 months. The average price of BHP shares John purchased is $36.04 (equal to $12,000 divided by 333).
By making smaller, regular, investments John has not tried to pick the optimal time to invest. He has accumulated shares at an average price of $36.04 and the share price in the last month of his investment is $39.40.
Obviously share prices go up and down over time. Where this strategy works well is where you have medium to long term goals say, a three to seven years time horizon.
Please note that we strongly recommend that when adopting this approach you diversify your portfolio, that is, do not limit the investment to only one company such as BHP.
You do not need a large amount of money to be a successful share market investor. What is important is making a commitment to a regular savings plan.
Remember, when looking to make any major financial decisions it is strongly recommended that you seek independent professional advice. This will ensure that you are making the best decisions for your individual situation as not one solution provides optimal results in every situation. Should you have any questions or require more information regarding investment, financial planning or tax advice contact us on 1300 QUINNS (784 667) or click here to submit an online enquiry.
