You may have heard of something called dollar-cost averaging (DCA). It’s when you buy a certain dollar amount of an investment on a regular schedule. Meaning that if you committed to spending $1,000 and shares were at $2, you would purchase 500 shares. If they were at $200 on the following purchase date, you’d buy only five shares.
Can it be a good strategy? That’s a matter of opinion. Here’s what two experts say about DCA.
First Opinion: Moshe A. Milevsky, a professor of Finance at the Schulich School of Business, York University, says ditch DCA.
Using DCA is a reasonable financial-planning strategy. But as an investment strategy, it doesn’t make sense. You see, DCA is a bearish bet on the markets.
You’re buying a few units now, in hopes you’ll be able to buy more later when they get cheaper.
As such, DCA boils down to market timing, and any investment strategy that tries to outguess the market is predestined for mediocrity.
From an investment point of view, you are fooling yourself. If a person invests slowly as opposed to all at once, he can say, “Good thing I didn’t go all in” if the markets move down. In reality, however, DCA didn’t make the final outcome any safer — or even provide a better return.
Proponents of DCA say if you invest in markets gradually, you reduce the general level of risk in your portfolio. But having a properly diversified portfolio from day one lowers volatility and delivers higher returns.
Second Opinion: Peter Andreana, partner at Continuum II Inc. in Burlington, Ont., argues that there’s still value in DCA.
DCA allows you to make saving and investing habitual.
When you buy investments monthly, you average out the purchase price, and eliminate the emotion involved in when and how much to purchase.
If you purchase investments once or twice a year, you risk buying based on emotion — that’s dangerous. Also, squeezing in a lump-sum RRSP contribution at the end of February could mean you’re buying at the most expensive time of the year.
In reverse, DCA can be detrimental. If you need $50,000, you should not take out a monthly amount based on retirement needs.
Instead, if you need to withdraw invested funds, you should do so based on units. In a good market, generating $5,000 a month could take 5,000 units, but in a bad market you could need 6,000 units to generate the same $5,000.
In this scenario, you’d be burning through investments significantly faster than planned.
The only way to have your money invested in the markets and live off those funds would be to fix the number of units withdrawn each month. So, in this more favourable scenario you would withdraw 5,000 units a month and in good markets, you would cash out $5,000, while in bad months, maybe $4,000.
DCA makes a ton of sense during volatile times, since there’s no emotion involved in financial decisions. It’s automatic.
In volatile times, it also has the benefit of encouraging continued investing through good, bad and ugly times. If you’re not using DCA, you’d need to think about when your’re going to invest and how much.
That typically means when the markets get really ugly, you’re too scared to invest — even though that might be the very best time.
Katie Keir is assistant editor of Advisor Group.