How dollar-cost averaging makes the most of your savings
By Jim Middlemiss • Bankrate.com

Canadians looking to grow their investment portfolios should consider dollar-cost averaging. Not only can it can lead to lower investment costs and reduce market risk, it can also help you build better money management habits, according to experts.

"It doesn't guarantee a better rate of return, but it does guarantee discipline," explains Patricia Lovett-Reid, vice-president and managing director of TD Wealth Management in Toronto.

"In the absence of a (financial) plan, people tend to allow emotions rather than fundamentals dictate investment decisions. Dollar-cost averaging reduces the tendency to lean toward timing the markets," she says.

"Because the amount you invest is constant, you buy more units when the price is low and fewer units when the price is high," explains Tania Slade, regional manager of BMO Mutual Funds in Toronto.

It's also a versatile strategy -- you can use it to buy stocks, mutual funds, income trusts, bonds or even hedge funds.

A little can turn into a lot
Here's how it works. First, decide how much you can afford to invest each month and stick to it. Then, find an investment that you want to hold for the long term.

Then, pick a regular interval to buy into the investment -- such as once a month, once a week, biweekly or quarterly -- and when the time comes, buy as much of the investment as you can for your fixed amount.

Here's an example, which commits $100 a month to buying units of an equity mutual fund:

After six months, your total investment is $600. During that time frame, the mutual fund averaged a price of $8.16 a unit. However, your adjusted cost base -- the price attributed to each unit you own, which is the figure used to calculate your capital gains or loss when you sell -- is only $8.03. That's because you rode the ups and downs of the market, buying more when it was cheap and less when it was expensive, taking advantage of the swings that occur in the market.

If you had invested all $600 at once in the first month when the unit cost was $10, you would own 60 units and be looking at a loss of almost $2 a unit. By using a dollar-cost averaging strategy, you have 25 percent more units and a potential capital gain of almost $1 a unit or $100 total, based on the last trade price of $9.

Of course, if you waited until the fund bottomed out at $6, you could have bought many more units and had a bigger potential gain, but that assumes you could have efficiently timed the market, which both Lovett-Reid and Slade advise against.

"You don't want to second-guess yourself," says Lovett-Reid. She says trying to time the market can lead to excessive trading and over-confidence.

"You get a bigger benefit and reduced risk by (investing) gradually," adds Slade.

Good strategy for small or beginner investors
Dollar-cost averaging is a good strategy for those trying to grow a small portfolio or who don't have a large amount to invest but still want to put some money aside for retirement.

The earlier you get in the market and the longer you keep it invested, the more your portfolio will grow thanks to compounding interest. Even if you can only afford to invest $50 a month, that's better than doing nothing.

One thing to watch out for, though, is how much you pay in commissions. If you invest small amounts and pay a commission each time, it will quickly eat into your stake. So, look for no-load or low-fee mutual funds.

If you want to use the strategy with individual stocks, then consider some of the dividend reinvestment plans (DRIP) and share purchase plans (SPPs) that large firms provide. Most of Canada's big banks and telephone companies -- as well as some mining companies, income trusts and exchange-traded funds -- have DRIPs or SPPs.

Once you buy into the stock, with as little as one share, you can buy more without paying commissions, and the dividends can also be directed to acquiring more stocks. To learn more about DRIPs, see Bankrate.ca's Cheap but effective investment strategies.

When establishing your dollar-cost averaging strategy, Lovett-Reid advises against investing at the beginning or end of the month because most economic news comes out the first Friday of the month, making it a volatile time for the markets. Also, watch out for earnings season, when public companies announce their financial figures. That can also create a market frenzy and see you paying more for an investment than it's worth.

Jim Middlemiss is a freelance writer and lawyer based in Toronto. He's a frequent contributor to the National Post, Investment Executive and Wall Street & Technology.