By Colin Lewis, Head of Strategic Advice, Fitzpatricks Private Wealth
November 2023

We live in turbulent times.

It’s been a volatile time on the markets.

The tax benefits of superannuation and the risk-mitigation and potentially cost-cutting benefits of ‘dollar cost averaging’ mean that sticking with a disciplined contributions strategy remains compelling even when investment markets are moving against you.

Whilst superannuation is the largest asset after the family home for many Australians, remember it’s an investment vehicle, not an asset class.

Regardless of whether you invest via a super fund or personally outside super, it’s what you invest in – cash, shares, property etc. – that dictates how your wealth fares. Super, being a structure, does not lose you money.

When markets are volatile, you may be reluctant to invest and cease making voluntary super contributions. But super is for the long-term and short-term volatility can be a good time to top up. After all, you’re buying assets that are cheaper and unless you’re just about to retire, you have years – maybe decades – for the market to move back in your favour.

Volatility can lead to anxiety and it’s easy to rationalise the need to ‘wait and see’. You could try and time the bottom of the market – good luck – or wait until confidence returns before investing. Ironically, even when markets recover, many investors wait for the market to fall again in the hope of picking up bargains.

Unfortunately, these approaches are flawed and can create ‘investor paralysis’. And delaying investing may mean missing out on participating in the upside when markets inevitably recover.

It’s important to find ways to manage emotions to achieve our long-term goals.

Dollar cost averaging

One powerful way is ‘dollar cost averaging’ which involves making regular deposits into an investment at regular intervals over a period of time.
Importantly, this investment method can reduce the risk of investing during times of market volatility. It also helps avoid the pitfalls of attempting to ‘time’ entry into markets. Dollar cost averaging overcomes ‘investor paralysis’ by giving you the opportunity to build exposure to growth assets in a disciplined way.

Take Bob and Joan who each have $200,000 to invest in a managed fund – which entails purchasing ‘units’ representing the value of the fund’s underlying assets often comprising Australian and international shares.

Bob invests all in one go when the unit price is $1.00 and gets 200,000 units. The unit price then dives to $0.70 and his investment is only worth $140,000. It then gradually recovers to $0.80 then $0.90 and in period 5 is $1.10. Bob’s patience has paid off as his investment is worth $220,000.

Joan, on the other hand, is apprehensive about investing due to market volatility but is prepared to invest her $200,000 gradually in equal instalments over the same set periods.

Joan’s initial $40,000 investment acquires 40,000 units. The second $40,000 buys 57,143 units at $0.70. Joan’s third $40,000 gets her 50,000 units. Fourth, 44,444 units and final $40,000 investment gets her 36,363 units at $1.10. Joan ends up with 227,950 units in the managed fund and has a better outcome because her investment is worth $250,745.

By committing to regular investment amounts, Joan overcame ‘investor paralysis’ and purchased the managed investment units at a lower average unit price of $0.88.

This is the essence of dollar cost averaging. When you commit to investing a fixed amount into an investment that varies in price, such as shares or managed fund units, you purchase more when the price is low and less when the price is higher.

It’s not a guarantee of maximising returns and it doesn’t mean you should never invest a lump sum as part of a long-term financial strategy. Rather, it’s a way to potentially lower the costs of investing and a powerful risk reduction strategy for investors who would otherwise be reluctant to stick to a long-term investment plan in the face of volatility.

The good news is that dollar cost averaging is how most wage earners invest in super – via their employer’s regular compulsory super contributions. In addition, most salary sacrifice contributions are made via regular contributions.

That’s why its important investors don’t lose faith and reduce their contributions when markets are weak because in many ways that’s when dollar cost averaging works best.

Super

Investing for your retirement via pre-tax concessional contributions to super is an effective way to invest because of the significant tax benefits. Importantly, they ‘insulate’ you from making a loss when markets fall.

You are better off investing via super as the tax benefits protect you.

Take Toni who earns $150,000 a year and is on a tax rate of 39 percent (including Medicare levy). By making pre-tax salary sacrifice or personal deductible contributions Toni puts 85 cents of each dollar to work in super as opposed to only 61 cents had she paid tax and invested outside super.

The tax benefits of super make it hard for Toni to lose money. The money she saves in tax means her super investments must drop 28% before she is worse-off from continuing with her super contribution strategy.

Given it’s extremely rare for someone to be invested entirely in equities, the decline in markets needs to be even greater than this to be worse off – assuming other asset classes haven’t fallen simultaneously.

If Toni had a 70% exposure to equities in super, the market must drop 40% for her to be worse off – and that obviously hasn’t happened.

In volatile times, the tax benefits of super make it still compelling to stick with a disciplined contributions strategy, especially when it’s done in conjunction with dollar cost averaging.