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April 06, 2009 at 08:00 PM
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It’s impossible to predict when the market is going to change, but that doesn’t mean your clients shouldn’t dip their toes into the investment waters. Dollar cost averaging (DCA) is a good way to ease your variable annuity clients and prospects into a well-diversified portfolio at a comfortable pace.
DCA is an arrangement that allows your clients to invest a fixed amount of money into a fund or investment option at regular intervals regardless of what the market is doing. Conventional wisdom tells us that with a disciplined approach to investing over the long-term, such as dollar cost averaging, clients may purchase more shares or units when prices are low and fewer shares when prices are high. Of course, dollar cost averaging can’t guarantee a profit or protect against a loss.
To demonstrate how the discipline of DCA could be a good tool for your clients, think about the following: Clients can get nervous when the market falls (let’s face it, so can professional advisors), and become fearful that if they hold onto investments too long they will lose more and more. Therefore, they may unload shares as the market descends, or conversely, get caught up in buying shares as the market rises. Dollar cost averaging can help combat this fear. Instead of purchasing a fixed amount of shares all at once, shares are bought on a regular basis as prices fluctuate, and clients may actually pay an average cost that is lower than the average price over the long term.
In a variable annuity, it is typical for DCA programs to allocate client dollars into a fixed account (or money market account) initially. The account pays a stated interest rate and then automatically transfers money every month or quarter for a certain period of time, into variable investment options.
Dollar cost averaging is nothing new. This tried and true strategy has been used for decades to help clients ease into the market. Some variable annuities on the market today offer a newer strategy called Enhanced DCA (EDCA). EDCA arrangements provide additional flexibility to design customized strategies for your clients. With an EDCA program, the period of time the money is invested in a fixed account may be shorter, typically six months, but the interest rate is greater than the normal DCA interest rate.
For example, a client might invest $120,000 into a variable annuity using a six-month EDCA with a current annual interest rate of 6% and request $20,000 in transfers each month. Since the unit values of variable investment options fluctuate daily, using a six-month EDCA to invest at regular intervals means your clients will be investing in variable investment options at a variety of unit values, sometimes high, and sometimes low.
