Taking Advantage of Dollar Cost Averaging in a Market Downturn
With the situation occurring in the global economy, many of our clients have been reaching out to us, indicating they feel that now is a great opportunity to invest assets that they otherwise had sitting on the sideline, perhaps stored away in savings accounts, GICs, or Term Deposits. Although we agree that the recent decline in the markets provides certain investors great opportunity, sound strategy must guide investor actions in times such as this.
It is significant to mention that the strategy discussed is for investors that are still accumulating and growing their wealth, as opposed to investors who are using their assets to provide them with a steady flow of income in the form of withdrawals.
The full extent to which the economy will be impacted by coronavirus has yet to manifest, however, many economists believe that we can expect volatility over the next 18 to 24 months, as the dust settles and companies provide the market updates on their earnings.
Why not try to time the market?
During times such as this, with periods of high short-term volatility in the markets, the Unit Price of a security will see sharp spikes upwards and downwards. Ideally, the perfect investor would know exactly when the security reaches its lowest value, and purchase at that time. The simple truth is that no person can tell you exactly when this will happen, not even Warren Buffet himself, and due to this, there is much more risk in trying to perform this action, termed ‘Market Timing’. Quite simply, it’s impossible.
What is Dollar Cost Averaging?
Taking this into consideration, for investors looking to increase their exposure to the market, but looking to do so in the most methodical way possible, this is the perfect scenario for Dollar-Cost-Averaging (DCA). DCA is the strategy whereby an investor makes periodic investments over time to their portfolio instead of one time, lump-sum deposits. This can be accomplished through monthly, bi-weekly, or even weekly contributions into their investment account.
DCA is not a new concept, and it was Benjamin Graham who discovered this key strategy for helping smooth out negative short-term effects of marketplace volatility in the 1930’s. A major influence in the investing success of high-powered business magnate Warren Buffet, Graham has written acclaimed books such as Security Analysis (1934) and The Intelligent Investor (1949). As financial advisors, building in periodic investment, typically in the form of a monthly deposit, is a standard recommendation we make for most investors.
There are 3 main benefits to establishing an investment strategy that includes DCA:
- Allows to investors to take advantage of the opportunity presented to them.
By establishing a DCA plan, you can rest assured knowing you are taking advantage of the opportunities that present themselves in times of volatility. - You are able to smooth out short-term volatility when investing in securities.
Investors continue to contribute to the securities in their portfolio, when the market rises or falls, and the short-term market volatility, or Market Risk, is smoothed out over time. - You are able to remove your own biases, and be an emotionless investing machine.
All investors are human, and as so, we are all subjected to the biases that fund a portion of our human nature. With money brings emotions, with falling markets brings even stronger emotions. By working with your Financial Planner to determine your DCA plan, you can rest assured that even if we are to see more of decline, you are still contributing into your portfolio at an even lower Unit Price than previously.
Simply put, it is unknown whether this is the worst we will see from the markets. By establishing a plan to invest, and sticking to it, no matter the short-term fluctuations, your emotions will not get in the way of you accomplishing your investment objectives.
