When is the best time to invest? If you are afraid of doing the wrong move at the wrong time, you may be tempted to stagger your investment over time: this is called in the US “dollar-cost averaging”. This strategy, applicable anywhere in the world, can even become a recurring method of investment.
For an investor, the principle of averaging consists of staggering his investment in several tranches acquired at regular intervals, without taking into account the market price, in order to minimize the risk of bad timing and reduce the impact of volatility.
Rather than investing a large sum at once, also known as “lump-sum investing”, staggering your investments means that you do not put the entire amount to be invested at risk directly and benefit from a possible drop in prices following the purchase of the first tranche. It is more of a portfolio risk management strategy than a profit maximizing strategy.
Averaging is also a good antidote to cognitive biases that tend to induce irrational behavior in investors. Averaging, by its regularity over time, makes it possible to avoid a whole series of errors of judgment linked to the context and therefore to rationalize the investment process.
In favorable market conditions, averaging will reduce the average cost of investment. In the event of a rise in prices in the longer term, the gain will thus be reinforced; in the event of a drop, the loss will be reduced.
On the other hand, if the price of the target asset only goes up, the average price obtained by averaging will also increase. In this case, the profit for the investor will be lower than if he had invested everything at once. Finally, you have to take into account transaction costs which, with a strategy of regular purchases, can also affect the total return.
Ultimately, it is the market conditions that will make investing all at once or in installments more advantageous. The choice of one or the other strategy will depend on your expectations and your risk tolerance: if you anticipate a bull market and you are very risk-tolerant, investing in one go will probably be appropriate. If you anticipate high volatility and have low risk tolerance, averaging could be a wise solution.
Since the investor's bet is that prices will rise over the long term, it is more dangerous to practice averaging on an individual stock than on an index fund: the risk of seeing this stock fall permanently over time, and therefore to finally materialize a loss, is significantly higher than on an ETF.
You had €1000 to invest at the beginning of 2022. Rather than investing all at once, you decided to invest every first working day of the month €200 in an ETF that replicates the global equity index. Here is the result of this strategy:
|Date||MSCI WORLD ACWI IMI Index||Investment||#shares bought|
|Average purchase price||Total invested||Total shares bought|
Compared to someone who would have invested €1000 on January 3, 2022, you obtained a lower average price per security and therefore bought a higher total number of securities. When, as you hope, the price of the index goes up, the profit that you can materialize will be higher. Market conditions here were favorable to averaging; this was not the case at the same time in 2021, for example. But once again, remember that it is not so much a question of maximizing profit as of reducing risk: in 2021 as in 2022, you would thus have effectively reduced the risk of your portfolio, albeit with a variable financial result.
Alongside averaging, rebalancing is another way to reduce the risk of an investment portfolio. This involves regularly reselling some of the outperforming or riskier assets and reallocating the cash thus obtained to less efficient or less risky assets. In this way, you maintain over time the asset weighting that best corresponds to your risk profile.
If averaging can be useful when investing a large sum of money, it can also become a recurring mode of investment: each time a sum is available, it is invested, regardless of the market price.
When you make a simulation on easyvest’s website, you are encouraged to plan recurring payments to feed your investment plan. It is both an incentive to save and a form of averaging: by doing so, you will reduce the risk of volatility in your portfolio. In practice, easyvest will invest every €500 available: if you add €100 per month to your account, we will invest the funds every 5 months.