The market volatility over the last couple of months may have some investors wondering if they should pause their monthly contributions until the economy improves, or at least until we are all back to work. As many investors know, these ups and downs can wreak havoc on our portfolios and emotions. However, history has shown that in times of turmoil, sticking to a disciplined strategy can pay off. 

Dollar Cost Averaging (DCA) is a financial-planning strategy used by investors who purchase an investment on a regular basis with a predetermined dollar amount.  Having money deducted out of your bank account monthly and invested into your RRSP is a perfect example. 

DCA allows you to make saving and investing a habit.  When you purchase investments monthly, 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 in times like now; when the markets are volatile, it takes emotion out of the investment decision and it is 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.

One historical time-period when dollar-cost averaging may have worked was the market volatility we experienced in 2008. The below graph shows the difference in a hypothetical portfolio using dollar-cost averaging starting on September 1st, 2008, compared to a lump sum investment on that same date. While it is important to note that dollar-cost averaging does not always produce a higher-end return versus a lump sum, its systematic approach takes the emotional side out of investing and may help investors stay the course.

Source: Dynamic Funds and Morningstar Direct
Hypothetical investment in S&P/TSX Composite TR. Dollar-cost averaging assumptions: Contributions of $400 at the beginning of each month, starting from Sep 1, 2007 to Sep 1, 2009. 25 Contributions totaling $10,000.

Periods of volatility have peppered the markets over the past century. Advocates of DCA believe that by investing in the market gradually over time, you will reduce the risk in your portfolio.  Although this may be true, I also believe that having a properly diversified portfolio in-line with your risk tolerance is the best way to lower your volatility and provide you with positive returns over time.

Nevertheless, I have always believed the best time to invest is when you have the money.  If that is monthly 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, Dynamic Funds website