While it might sound complicated, dollar-cost averaging (DCA) is a simple concept that can lead to results that are anything but average. Rather than keeping your money in your bank account or trying to “time the market” (i.e., buy low, sell high) with DCA you invest a fixed amount every week or month, regardless of market conditions. It's like a steady heartbeat for your investments, pacing and averaging out the market's ups and downs over time.
DCA works well for just about any type of investment where you can buy in smaller increments, but it is most closely associated with equities – like stocks, mutual funds and exchange traded funds (ETFs). It enables you to benefit from the growth of companies over time while minimizing the impact of market fluctuations.
Implementing a DCA-based strategy
Let's look at a simple example of a DCA strategy vs. a lump sum purchase in which you decide to invest $8,000 a year in Company B over the next ten years. Here is what that could look like in the first year when you use DCA and make $2,000 purchases every quarter vs a $8,000 lump-sum purchase at the beginning of the year:
| Period | Market Price | Amount Invested | Shares Purchased |
|---|---|---|---|
| Dollar-Cost Averaging | |||
| Q1 | $10.00 | $2,000 | 200 |
| Q2 | $12.50 | $2,000 | 160 |
| Q3 | $8.00 | $2,000 | 250 |
| Q4 | $10.00 | $2,000 | 200 |
| Total | $8,000 | 810 | |
| Lump Sum | |||
| Q1 | $10.00 | $8,000 | 800 |
| Total | $8,000 | 800 | |
The total amount invested in both scenarios is $8,000, but the number of shares purchased with DCA is 810 while only 800 shares were purchased with the lump sum. You were able to buy those 10 additional shares for the same $8,000 even though the share price fluctuated throughout the year since you bought more shares when the market was declining and fewer when the market was rising. In this case, the average share price using DCA was $9.88 and $10.00 using the lump sum method. That may not sound like a lot, but over the long term it can amount to significant additional value.
Benefits of Dollar-Cost Averaging
- It's easy! Just set up regular scheduled deposits and don't worry about timing the market.
- Less risk of making investment decisions based on short-term market fluctuations.
- You buy more shares when prices are low and fewer when prices are high (like in the example above).
- Promotes a consistent, long-term focus on saving and investing.
- Supports goal-oriented financial planning such as saving for a new home or retirement planning.
How does DCA work with my RRSP and TFSAs?
DCA is a strategy well-suited to registered accounts like RRSPs, TFSAs, as well as the new First Home Savings Account. Making regular contributions to these accounts helps ensure that you take advantage of the tax deferral or sheltering these accounts offer. Making regular contributions also helps maximize the value of your portfolio over time as we saw in the example above. Keep in mind that these accounts have very specific rules around contribution limits and tax consequences for early withdrawals.
Quiz time: Do you know the ins and outs of Dollar-Cost Averaging?
Is it hard to get started with DCA?
You don't need a big bankroll to start, and it works for pretty much any type of investment. Just be mindful of trading fees, and always check with your investment advisor before making any moves.
A CERTIFIED FINANCIAL PLANNER® professional at CDSPI Advisory Services Inc. can play a crucial role in tailoring a DCA strategy to your specific financial situation. They can help you to define your goals, assess your risk tolerance, and create a personalized plan aligned with your needs. Book a meeting to get the conversation started.