Dollar cost averaging (DCA) is one of the most common investment strategies for everyday investors. It simply involves contributing to your investment portfolio gradually over time, rather than investing a lump sum all at once.
This is the default approach for superannuation contributions, and it’s how most people invest their surplus cashflow – often monthly, with consistency over time.
Meanwhile, debt recycling is becoming more popular as a way to make long-term investing more tax-efficient. This raises a practical question: can dollar cost averaging and debt recycling be used together?
Is It Possible?
At first glance, the answer seems to be no – or at least, not without adding a layer of complexity that would make most accountants shiver.
The challenge lies in how investment loan splits work. Before funds can be redrawn from a split for investment purposes, the split must first be fully paid down. But with many banks imposing minimum split sizes of $20,000 to $50,000, it’s clearly well above what most people can invest on a regular basis. You can’t use a single loan split for dollar cost averaging without creating a mixed loan.
This leaves the only option of saving up regularly until you have enough to pay down a new split. From there, you can redraw and invest gradually. But there’s an obvious problem. For example, saving $1,000 per month would take 20 months to accumulate the $20,000 required to even get started – only then can you begin dollar cost averaging those same $1,000 amounts.
So, the problem isn’t with dollar cost averaging itself really – it’s with the lack of capital to front-load the split. If that can be overcome, DCA and debt recycling can work well together.
There are two practical ways to do this, depending on your circumstances.
Note: This article assumes you already understand the mechanics of debt recycling. If not, it’s best to familiarise yourself with it first.
Option 1: Pre-Funding the Investment Split with Cash
This option assumes the investor has enough cash savings available to temporarily fund a new loan split, even if they would prefer to invest using ongoing monthly surplus. It allows dollar cost averaging (DCA) to occur through debt recycling, without the need for a large one-off investment.
Scenario
Consider a couple with $1,000 per month in surplus cashflow they want to invest. They also have $50,000 in an offset account against their home loan, which they want to retain for emergency access.
To invest the $1,000 per month while also implementing a debt recycling strategy, they could do the following:
Step 1: Create a New Loan Split
As with any debt recycling strategy, a new loan split is required. The size of this split should reflect how much the investor is willing to temporarily move out of easy access. For example, 24 months’ worth of investments.
In this case, a new split of $24,000 is created.
Step 2: Use Cash Savings to Pay Down the Split
The $24,000 from the offset account is used to fully pay down the new loan split. This creates $24,000 of redraw capacity. Although the funds are still accessible, they should now only be used for investment purposes to maintain the integrity of the loan.
Step 3: Invest Monthly via Redraw
Each month, $1,000 is redrawn from the loan split and invested into income-producing assets. This mirrors the typical dollar cost averaging approach, whilst ensuring that each $1,000 drawdown generates deductible interest.
Since the split should only ever be used for investing, the loan remains clean and fully deductible.
Step 4: Rebuild the Offset Balance
With the $1,000 being saved each month, this can be directed back to the offset account on the main loan. After 24 months, this would replace the $24,000 that was originally taken from here to fund the redraw in the new loan split.
Outcome
This approach enables the couple to invest gradually using DCA, while also ensuring the interest on the invested amounts is tax-deductible – effectively converting personal debt into deductible investment debt over time.
Importantly, their net debt position hasn’t changed at any point. They’ve simply redirected their savings temporarily to enable debt recycling.
Once the redraw capacity is exhausted and savings are replenished, the process can be repeated with a new loan split.
Considerations
There are some features of this strategy that should be considered before committing to it:
Access to cash is reduced
While the $24,000 remains technically accessible via redraw (subject to bank conditions), using it for personal spending would contaminate the loan and lead to a mixed loan. Any non-investment drawdown should only occur in genuine emergencies. It may be difficult to unwind.
Don’t use all your savings
It’s rarely a good idea to use all available cash savings for this strategy due to the risk of needing it in an emergency.
Interest-only may be preferable
Using an interest-only (IO) structure for the new split keeps the balance intact while investments are gradually made. This maximises the deductibility and simplifies cashflow management. If the loan is principal and interest (P&I), the balance may begin to reduce before all funds are invested. Whether IO is worthwhile depends on the interest rate differential between IO and P&I loans.
Option 2: Front-Loading with a Cash-Out Loan
Option 1 won’t suit everyone – particularly those with limited savings or who prefer to keep their offset account intact. An alternative is to draw on home equity to fund the front-loading process instead.
This approach uses a cash-out refinance (or equity release) to provide the capital needed to set up a new investment split – without using personal savings. Existing available redraw on a loan could also be used.
Here’s how it works:
Step 1: Apply for a Cash-Out Loan
Using the same $24,000 example, you apply for a new loan secured against your home. This loan is not used for investment purposes directly, so the interest will not be deductible – but that’s okay. You’re simply using it to unlock capital to fund the debt recycling process.
Step 2: Create a New Loan Split
As with any debt recycling strategy, a new loan split should be created – in this case, $24,000. This split is where the investment redraws will occur.
Step 3: Use New Loan Funds to Pay Down Split
The $24,000 from the cash-out loan is then used to fully pay down the new split. This creates available redraw capacity for investment.
Step 4: Invest Monthly via Redraw
You then draw $1,000 per month from the investment split and invest it into income-producing assets. The interest on this loan split is deductible, as it directly funds investments.
Step 5: Repay the New Loan
The $1,000 of monthly surplus cashflow can now be directed toward repaying the cash-out loan. After 24 months, the loan should be fully repaid, and the strategy can be repeated using the same process.
Outcome
This strategy achieves the same result as Option 1, a gradual investment of $24,000 over two years with deductible interest, but without using personal savings. Total net debt remains unchanged, and the only difference is the source of funds used to front-load the investment split. Because the cash-out loan will be paid down monthly, it can be reused to fund future splits as needed.
Technically, it’s possible to skip Step 2 (opening a new split) and dollar-cost average directly from the cash-out loan. In that case, surplus cashflow could instead be used to pay down the main mortgage, which could then be redrawn to fund future investments. However, this approach is more likely to result in a mixed loan and complicate interest deductibility. Cash-out loans may also attract higher interest rates, making it more efficient to invest through a dedicated loan split.
Considerations
This strategy is clearly more complex than option 1, and has some more things to be aware of:
Interest-only even more preferable
Choosing to make the cash-out loan interest-only (IO) can improve flexibility. As monthly repayments are made from surplus cashflow, the outstanding loan balance reduces – and with it, the interest charged. Over time, the minimum repayment will decline, eventually reaching zero once the loan is fully repaid.
Alternatively, rather than making repayments, monthly savings can be placed into an offset account linked to the loan to achieve the same effect.
That said, it’s not essential to structure the loan as interest-only. Even if it’s principal and interest, the required principal repayments can simply come from the $1,000 per month that’s already being directed toward the loan. This will just reduce the total amount available to be redrawn, which is relevant if the loan is to be used again.
Issue if turning into investment property
Having a recently drawn cash-out loan on a property that later becomes an investment can complicate interest deductibility. The purpose of the funds will still matter for tax purposes – and here, they weren’t used to generate rental income.
However, it doesn’t necessarily create a problem that wasn’t already there (equity is being drawn upon, not changing the nature of an existing loan), but it’s worth understanding the implications in advance.
Fees and Approval Conditions
Some lenders may charge fees for cash-out refinancing or limit the amount of equity that can be released. Be sure to check whether these costs outweigh the benefits.
Conclusion
It’s often said that dollar cost averaging can’t be combined with a debt recycling strategy, but the two strategies outlined here show that this isn’t necessarily true.
That said, they do add complexity. A misstep, especially when using an equity release loan, can create structural tax issues. This second option is likely only suitable in very specific or constrained circumstances.
By contrast, using your own cash to front-load the loan split is a lower-risk way to start debt recycling immediately, without needing to first build up a large lump sum – as long as the rules around redraw use are clearly understood and carefully followed.
As always, speak with a qualified tax professional before implementing a strategy like this to ensure it suits your circumstances and is set up correctly.
We’ve already written about some of the ways to mess up debt recycling, and there are plenty.
