Dollar Cost Averaging – Good or Bad?

Most people have heard of the strategy Dollar Cost Averaging (DCA), it is when you purchase an investment on a regularly basis with a predetermined dollar amount.  Having money deducted out of your bank account on a monthly basis and invested into your RRSP is a perfect example. 

Is it a good strategy?  That is a matter of opinion.  Here is what two experts say:

First Opinion:  Moshe A. Milevsky, a professor of Finance at the Schulich School of Business, York University, says forget DCA.

Dollar Cost Averaging is a useful financial-planning strategy; however it is not a good investment strategy.  Dollar Cost Averaging is a bet that the markets will go down.

You are buying a few units now, in hopes you will be able to buy more later when the price goes down.  Therefore, DCA is a type of market timing, and any investment strategy that tries to outguess the market is predestined to fail.

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 provide better returns.

Believers of DCA argue that if you invest in the market gradually over time, you will reduce the risk of in your portfolio.  However, having a properly diversified portfolio from the beginning is what will lower the volatility and provide you with higher returns over time.

Second Opinion:  Peter Andreana, partner at Continuum II Inc., Burlington, Ontario argues that there still value in Dollar Cost Averaging.

DCA allows you to make saving and investing a habit.  When you purchase investments on a monthly basis you average out the purchase price, and eliminate the emotion of how much and when to invest.  If you purchase investments once a year; you risk buying based on your emotions and that can be dangerous.  Furthermore, squeezing in a lump-sum RRSP contribution in February could mean you are investing at the most expensive time of year.

DCA makes a lot of sense when the markets are volatile, it takes emotion out of the investment decision and it’s automatic.  In volatile markets, it also has the advantage of encouraging you to continue to invest through the good, bad and ugly days of the markets.  Typically when the markets are ugly people are too nervous to invest – even though they know inherently it is the best time.  DCA takes the decision of when to invest and how much out of the equation.

My Opinion:  I have always believed the best time to invest is when you have the money.  If that is on a monthly basis or at the end of the year with your company bonus then that is the right time for you.  The important thing is to invest regularly, make it a habit and save for your future.

Have a great weekend,

Tracey

Source:  Original article posted on Advisor.ca by Katie Keir, 01-06-14