Share markets continue to be volatile and uncertainty continues to plague global economies. It is difficult to overcome the fear of investing when you are ‘once bitten, twice shy’. Furthermore, the idea of trying to pinpoint the exact time to jump back in to the market really falls into the category of speculation.

The aim of wealth creation is to invest regular amounts over a medium to long time frame. The definition of wealth creation is very specific in excluding speculative short-term trading strategies. Often the decisions to buy and sell speculatively are based around the more frequent ‘noise’ price fluctuations.

Speculating is a stressful way to live. It is very easy to find yourself checking share prices and portfolio balances daily (or more frequently). Such frequent observation can only lead to stress and anxiety. 

Wealth creation is supposed be about removing these stressful decisions and looking at the longer term prospects. One useful strategy to avoid the dangerous practice of ‘picking the right time’ is to invest on a regular basis – the concept is known as ‘dollar cost averaging’.

The idea of dollar cost averaging is that regular amounts are invested at regular intervals. By investing at regular intervals, you can take advantage of price falls and price rises and, therefore, pay an average price over the duration of the investment process. Such a process also accommodates smaller regular investment amounts as opposed to one large capital outlay. In one sense, dollar cost averaging is also a form of diversification.

For example, Barbara had $50,000 in a term deposit that matured four months ago. As interest rates had fallen, the rate at which she was able to reinvest was no longer as attractive as some blue chip dividends. However, she was not comfortable investing the whole amount in the share market at that time. So with the help of her adviser she selected a portfolio of shares. For simplicity, we will look at just one of the shares she invested in, called Company A.

If, over the last four months, she invested $1000 in Company A each month, the share prices would be as follows:

The average share price paid was $7.13, which is lower than the share price of $7.25 paid in Month 4. 

And so the process continues.

However, and most importantly, it is the recurring income from those shares over time that is most important. If you are interested in exploring a strategy suitable for your budget and income generation needs, please contact your adviser.

May 2009