How Dollar Cost Averaging Can Damage Your Returns

Over the past month I have seen investors go through a myriad of emotions from disbelief to fear and then greed. Right now, investors are looking for certainty in an uncertain market with many asking whether the market has bottomed and is this stock cheap, and can I buy it now. 

The more concerning question I am getting right now is from those who own stocks and are losing money, wanting to buy more because they believe the stock is cheap given it has fallen further.

It is one thing to attempt to bottom pick stocks that have fallen heavily but it is another thing altogether to increase your risk by buying more of the same stock that you are losing money on. But individual investors are not to be blamed for following the concept of dollar cost averaging given that it dominates the financial services industry investing mantra, despite it not delivering the results it claims.

Dollar cost averaging involves placing funds into an investment at regular intervals over a period of time regardless of whether the market is moving up or down. But this practice can significantly impact the performance of portfolios and not necessarily in a positive way. 

According to industry experts, dollar cost averaging reduces the risk of investing in volatile markets yet right now, we are in a very volatile market and people are losing money. The issue I have with this concept is that the industry promotes this practice stating that it helps to avoid the ‘so called’ pitfalls associated with ‘timing’ your entry into the market. 

But I would argue otherwise because this strategy is very questionable when markets are falling heavily, as you are subjecting your portfolio to a higher level of risk, which is exactly what you want to avoid in a volatile market. In my opinion, adding to an investment that is falling in value increases risk and should be avoided at all times. It is far better to wait for the dust to settle or buy an investment that is rising in value. 

What were the best and worst performing sectors last week?

With another shortened week due to Easter, the market was a little subdued. 

Last week Information Technology lead the way up over 6 per cent, Industrials was also up over 6 per cent whilst Consumer Staples was up over 5 per cent

After rising for the prior two weeks, the Energy sector fell away to be the worst sector for last week so down over 2 per cent. This was followed by Financials barely up rising just 0.20 per cent and Communication services up over 1 per cent.

Looking at the ASX top 100 stocks, we see Adelaide Brighton was the best performer up over 13 percent and this was followed by A2 Milk up over 12 per cent and surprisingly AMP was next up over 11 per cent. I say surprisingly as AMP has fallen over 80 per cent in the past five years and every time it has tried to rise in that time it has failed, so do not get too excited with this one.

The worst performers so far this week include Whitehaven Coal down over 10 per cent, Flight Centre down 9 per cent and Coca-Cola down over 8 per cent. 

What's next for the Australian share market?

The market has been rising over the past three weeks although momentum is slowing, which signals that the market is likely to start moving down soon to test the previous low. It has been 16 days since the low on 23 March and the market has risen 23 per cent with more than half of that rise occurring in the first five days. Right now, the market is indecisive and showing signs of weakness, so, while it is trading up, I don’t believe it will be for much longer. The best we can expect is for the current rise to continue for another week although I do expect it could start to fall away again any day. 

While the move up in price has been good, it has not been overly strong, and I would need to see more bullish signs before I can comfortably say the significant pullback is over. For this to occur, I need to see the market falling away to test the low of 23 March and then to hold above this point for a period of time. 

I still believe we have seen the worst of the market correction although I cannot discount that the market may fall below the low of 4,429 points set on 23 March. So, while many are jumping into stocks believing they are grabbing a bargain, right now there is a good probability that they may get more than they bargained for.

For now good luck and good trading.

Dale Gillham is Chief Analyst at Wealth Within and international bestselling author of How to Beat the Managed Funds by 20%. He is also author of the award winning book Accelerate Your Wealth—It’s Your Money, Your Choice, which is available in all good book stores and online.