Who Should Invest Every Month? - Maybe You!
One of the easiest, oldest and most popular investment strategies is dollar cost averaging, but how does it work and who should do it?
The theory behind dollar cost averaging is quite simple really. By investing the same amount of money on a regular basis (monthly, weekly or otherwise) you will buy fewer shares when an investment’s price is high and more when that price is low. This will result in an investor having an average purchase price lower than the share’s average price.
Here’s a practical example of dollar cost averaging. Let’s say we have two brothers John and Jim. On September 30, 2000 John starts to invest $100 a month into the S&P/TSX Composite Index. His brother Jim invests $6,000 as a lump-sum payment. 5yrs later on September 30 2005 John’s total rate of return is 90.97%* or 13.81% annually* and his investment value is $8,774.55*. Meanwhile Jim’s total rate of return is 15.73%* or 2.96% annually* and his investment value is $6,943.77*. While the difference may not always be this great, we use this as an example of how dollar cost averaging can help during a declining or fluctuating market.
Other than the technical advantage of dollar cost averaging there are also a number of practical advantages. First of all it allows you to “pay yourself first.” Too many people get in the mindset of “I’ll pay my bills, do my shopping and invest what’s left.” More often than not what’s left is nothing. By setting up automatic monthly payments into your investment, it becomes viewed as an obligation that needs to be paid. For many people this can be the biggest advantage to dollar cost averaging.
Another way that dollar cost averaging can help is by allowing you to spread your contributions out over the entire year, which for many people is very helpful. Most investors I speak to would like to maximize their RRSP contribution every year if they had the money, however a lot of people find it very difficult to come up with that lump sum payment right after Christmas. Dollar Cost averaging helps these people to meet the goals they set for themselves by breaking that payment down over a twelve-month period.
Now you have a basic understanding of what dollar cost averaging is and how it can help. The next step is to ask yourself if dollar cost averaging is right for you. You should sit down with an investment professional from Langlois Financial Services Inc. to discuss your individual situation and which strategies might work best for you.
*Based on Morningstar Bellcharts Software.