What is Dollar Cost Averaging?

Many clients my team work with wait on the sidelines saving their cash with the intention to invest eventually, or they don't think about investing until RSP season when they are reminded.

We have seen that they either end up investing the cash as a lump sum all at once because they waited until the last minute (ex. waiting to do a lump sum RSP contribution prior to the deadline), or because they are "timing the market" and waiting until they think it's a good price to pay.

While investing all your funds at one time at one price, or timing the market are strategies many investors take and can benefit from, there may be benefit for you to consider investing equal amounts of money at regular intervals, regardless of the price of a security. This is called Dollar Cost Averaging. I've compiled some information from TD on the topic below to help explain.

What is Dollar Cost Averaging?

Dollar cost averaging is an investing strategy that can help to minimize risk. Let's say you're thinking about investing in a particular stock, ETF, or mutual fund, the first thing you need to figure out is when to invest. If you invest everything at once, you have to worry about timing the market perfectly, so you can get the best price, which has always been difficult to do.

With dollar cost averaging, decide on the amount you want to invest over time, regardless of the share price. It's a way to help decrease the risk of paying up too much before the market drops. A benefit of this strategy is that you don't have to worry about timing the market at all – you're simply banking on the fact that you may pay a lower average price over time.??

The aim of dollar cost averaging is to reduce the impact of volatility – the rate at which the price of a security increases or decreases. When the price goes up, you get fewer shares for the same money and when the price goes down, you get more shares.

By making periodic investments, you're essentially trying to take advantage of the fluctuating share prices.

This is a strategy that tends to work better in the long-term. That's because asset prices tend to rise over time. It isn't the best option for short-term investing as that would bring back the volatility you were trying to avoid in the first place.

Pro's & Con's to consider:

Pros

• Reduces risk: This strategy allows you to average out the cost of your investment. This can help to reduce the risk of buying a lump sum before a big market downturn.
• Great for smaller budgets: It gets you on the investing bandwagon. So, what if you're making smaller plays? You can still get a feel for the market.
• Can help you avoid bad timing: You don't have to worry about predicting market swings because you're investing at regular intervals.
• No more FOMO: You won't get swayed by the fear of missing out.

Cons

• Higher transaction cost: Multiple purchases may result in higher transaction fees over time. In some cases, this may offset the gains accrued by the current assets in the portfolio. Chat with your Financial Institution or Advisor on what the fees are for transactions.
• You don't get in early: The market tends to go up over time. Investing a lump sum earlier may do better than smaller amounts invested over a period of time.
• Not exiting on time: It's easy to fall into the trap of not doing enough research and blindly following dollar cost averaging. This may encourage you to continue buying more stock at a time when you should simply exit the position.

What Advisors Are Saying?

I sat down with Roxxena Faird, Associate Investment Advisor at TD Wealth to get her thoughts on the topic:

"I personally use dollar cost averaging within my practice and it's a useful strategy for anyone new to investing or starting to build a portfolio with a lump sum of cash savings."

"Dollar cost average is a great approach when you are navigating volatile markets like what we have experienced over the past few years. It is the disciplined investor's compass in the turbulent sea of markets. By consistently and strategically allocating funds over time, you not only mitigate short-term market fluctuations but harness the power of disciplined wealth accumulation. This way we can avoid?making emotional or impulsive based decisions within our portfolio - which can ultimately negatively impact portfolio performance."

"I'd add that it's not just an investment strategy; it's a testament to the wisdom of resilience in wealth-building, anchored in the principles of patience and consistency."

Overall, dollar cost averaging can be a valuable strategy for investors looking to build wealth over the long term. By investing smaller amounts regularly, investors can mitigate the impact of market volatility, take advantage of the power of compounding, and reduce the risk of making costly emotional investment decisions by timing the market.

Check out this online calculator that can show you the impact of dollar cost averaging.

Do you take advantage of dollar cost averaging by investing regularly?