How dollar-cost averaging makes the most
of your savings
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
"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.While it may sound technical, dollar-cost averaging
is actually very simple. All it means is you invest a fixed amount of money in
a particular investment at regular intervals.
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
A little can turn into a lot
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:
Invested ||Number and price of units||Average|
|3rd month||$100 ||12.5
|6th month ||$100
||11.11 @ $9||$8.03 |
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.
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.
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.
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.
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.
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.
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
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.