Dollar-cost averaging can offer shelter in all kinds of weather.
Imagine that it happens to be a beautiful morning, but on the way out the door you grab an umbrella just in case. Fortunately, the day unfolds without a cloud in sight. The next morning is another perfect one, and you reach for the umbrella again. But why? The forecast says it won’t rain today either – but what if it does? Doesn’t it make sense to prepare for all kinds of scenarios?
The weather, just like the financial markets, can change in an instant – and when it does, you’ll be glad to have toted that umbrella along. After all, it seems only logical to try and protect yourself from uncertainty and to avoid the potential consequences of a sudden storm. Considering those consequences, are you willing to risk getting caught in a storm, or should you invest in the ability to see it through with less chance of harm?
Major financial markets have experienced a series of ups and downs since the record-setting days during the earliest months of the pandemic. But the old saying that “whatever goes up must come down” did eventually ring true as the global economy began to sputter and the bull market was replaced with a bear market. Since mid-2022, stock indices have retreated significantly from previous highs, leading to a general trading malaise and mediocre stock performance. The S&P/TSX Composite Index, for example, has been on the long road back towards its intraday high of 22,085 points (on April 4, 2022) for roughly 19 months (at/by Nov. ‘23) and counting.1
Introducing clients to a strategy
Given the uncharted waters of new economic realities, advisors are vital to helping their clients navigate and understand the advantages of investing wisely with long-term goals in mind. Any opportunity to inform clients about how and why certain investment strategies work is worthwhile. This includes talking to clients about the advantages of following a dollar-cost averaging (DCA) approach as opposed to parking capital on the sidelines and waiting impatiently for the next upward market swing to arrive. Of course, advisors know that it’s time in the markets – not timing the markets – that is critical to investing. Here’s a brief review of the main benefits that DCA offers to clients who are looking for an effective way to avoid complications and emotional decisions when it comes to investing.
- DCA reduces risk. A consistent, disciplined approach to regular unit purchases over a specified period will reduce the risk of being deflated by price volatility regardless of market activity. In effect, purchasing units in any kind of weather can reduce the stress and anxiety associated with short-term market fluctuations by lessening their impact.
- DCA reduces stress. Investing can be stressful, even for the most seasoned investors. Investing a large sum of money at once brings the concern of a market correction or downturn that could end up costing the client a significant loss. Assuming your clients want less, not more, stress and fewer things to worry about, DCA can provide an easier way to wade into the market. DCA offers a balanced entry point that averages out the impacts of highs and lows. After all, there’s no proven way to predict market behaviour beyond the fact that prices will rise and fall. A DCA approach can help clients take the intensity of those market swings in stride.
- DCA focuses on consistent value. Subscribing to routine investment purchases can take the emotion out of single transactions and dampen the distraction of daily market noise, helping clients find comfort in taking a longer-term view of their investments.
- DCA rewards patience. DCA is all about patient, consistent investing through all market scenarios to achieve long-term goals. Historically, major financial markets have proved resilient and eventually rebounded from downturns and corrections to make up lost ground, and hopefully even reach new heights.
- DCA takes advantage of downturns. Clients will undoubtedly welcome the “deals” that DCA can capitalize on. More fund units or shares are bought when prices are lower and fewer when prices are higher. Over time, this can potentially result in a more consistent cost basis during typical market fluctuations. Holdings can increase at a lower average price point during downturns, and provide enhanced growth when unit values increase, as shown in the chart below. Regular contributions mean never missing an opportunity to invest at low prices, which over time could result in a lower average investment price.
This hypothetical example demonstrates how an investor who purchases $100 of mutual fund units each month for a year will have accumulated 125.39 units at an average cost of $9.92. In comparison, a single $1,200 purchase at $10/unit would amount to 120 units.
*For illustration purposes only.
A version of this example also appears in a recent edition of Solutions magazine, which can easily be shared with your clients using the Solutions online email marketing tool.
Promote the benefits
While it would be nice to experience perfect weather every day of the year, recognizing there will be good days and bad days can make for a more reasonable approach to life – and investing. Market volatility, especially during changing and challenging economic times, can be punishing to those who might ignore warning signs and take too much risk. The same can be said for those who fear the worst and elect to sell their investments or convert everything to cash. Times of volatility present an opportunity to speak with clients and promote the benefits of staying invested. Moving forward with a DCA approach, once clients understand how it can help achieve their long-term investment goals, can lead to making the most of the inevitable ups and downs.
1 https://ca.investing.com/indices/s-p-tsx-composite-historical-data
