With share markets at all-time highs it’s a question of, how long can this go on for? When will a crash occur? When will prices drop? When should I invest – when the market crashes and stocks are cheap?
The ability to time the market can be a tricky exercise. It requires expertise and waiting for the opportune moment, but in most cases can lead to poor investment decisions or missing beneficial investment time altogether. This strategy is often known as a losing strategy as there is no guarantee that you will ever ‘time’ the market right. So, what method should we use?
There are two investing methods to explore: Lump-sum investing and dollar-cost averaging.
Lump sum investing is an all-in approach of investing one lump sum into the market. History shows that the market climbs more often than it falls and with this theory, lump sum investing provides instant exposure and should increase over time.
Dollar cost averaging is the little and often approach. This method means that the investor invests the same amount of money at a set frequency, weekly, fortnightly, monthly etc. If you think of how a KiwiSaver account is operated and where contributions are generally made on a regular basis – this is the same method. If the market has a downturn, this method means that more shares can be purchased at a lower cost. This method can also introduce investor discipline and prevents the investor from attempting to time the market because you’re buying all the time.
As an example, two investors decide to invest $10,000 each in one company. The first invests as a lump-sum in one go, the other invests the same amount in five monthly amounts of $2,000. In the five months, the share prices fluctuate – here’s what would happen to the investment:
In this example, person B ends up ahead. By investing a fixed dollar amount in the fund every month, Person B bought more shares when the price was low, less shares when the price was high, and ended up with more shares after five months, at a lower cost per share.
Which method is the best option for you? Whether you prefer to time the market, invest in lump sums or spend little and often, the method most appropriate largely depends on your investment timeframe, your goals or objectives and if you are looking to maximise returns or reduce risk.
Investing in lump sums can be ideal for shorter timeframes and may maximise returns however, can come at a higher risk. Dollar cost averaging offers a disciplined approach while reducing the risk of investing at market peaks. Every investor is different and what suits one may not suit others, so what is your style, all-in, or little and often? Or perhaps you are prepared to apply both methods and make the most of every situation.
The views in this article are of a general nature only and should not be considered
personalised advice. A disclosure statement is available and free of charge.