One of our favourite things about our job is onboarding new clients.
We enjoy getting to know them, their goals and their history. When it comes time to invest, we also realize that we are expected to deliver results. While no one can control the markets, we look for potential ways to increase successful outcomes. One strategy we have used over our careers is called dollar-cost-averaging (DCA). This is a fancy way of saying investing regularly over a time period.
With market valuations near all-time highs, we believe that a correction is coming. Generally, investors have three choices:
1. Invest a lump sum and ride the waves.
2. Wait for the market to fall and buy at a lower point.
3. DCA into the market to spread your risk.
Historically, option one has the greatest chance of success. A 2012 Vanguard white paper compared the results of an immediate lump sum investing (LSI) in a balanced portfolio (60 per cent stocks and 40 per cent bonds) versus buying equal amounts over a 12-month period in U.S, U.K. and Australia.
The study measured rolling 10-year periods from 1926 to 2011 and found the lump sum method won 67 per cent of the time. Furthermore, depending on the country people were invested in, LSI added between 1.3 per cent and 2.4 per cent. However, their study did not factor in the current valuation of the stock market. Another study done by Bloomberg in April 2018, found that DCA when markets were high helped reduce potential losses by nearly half.
Most people want to do No. 2, but this means you have to have the fortitude to buy when markets are dropping and the news is grim. Investors that are already fully invested need to get it right twice. They have to pull their money out at the top and put it back in when markets have plunged.
We have yet to see investors succeed at this because when things are bad, investors tend to expect market to go down further and typically decide to wait. Often, they are left idling in cash earning very little and paralyzed to make a decision. No one has perfect foresight and we suggest using a strategy that removes emotion and guessing market highs and lows.
What we like about No. 3 is that it has a psychological advantage and can be very effective when markets are trading at high valuations.
A simplified hypothetical example may help illustrate: Investor A has $100,000 and on Jan. 1 buys 5,000 shares of an investment at $20 a share. By June 30 of the same year, the shares drop to $15, then recover to $20 by the end the year.
Alternatively, Investor B buys in two lump sums of $50,000 each on Jan. 1 and June 30. This would result in buying 5,833 (2,500 plus 3,333) shares at an average price of $17.14. Amazingly, at the end of the year, she would have made $16,660 or 16.7 per cent while the actual investment returned zero per cent.
Typically, the best investments to dollar-cost-average are the most volatile. In addition, you want to buy as frequently as possible because it gives you the opportunity of buying at lower prices. With DCA, you actually want markets to drop to enhance your future returns.
Until next time, Invest Well. Live Well.
This document was prepared by Eric Davis, vice-president, portfolio manager and investment advisor, and Keith Davis, investment advisor, for informational purposes only and is subject to change. The contents of this document are not endorsed by TD Wealth Private Investment Advice, a division of TD Waterhouse Canada Inc.-Member of the Canadian Investor Protection Fund. All insurance products and services are offered by life licensed advisors of TD Waterhouse Insurance Services Inc., a member of TD Bank Group. For more information, call 250-314-5124 or email Keith.email@example.com.