I’m a risk averse person. I don’t bike in the city, I don’t enjoy jumping into water, and I don’t even dare go ten above the speed limit (put me in the slow lane, thanks very much). When it comes to my investments, it’s very much the same thing.
Despite a gold-plated public sector pension, I’m a big fan of holding 25% in bonds to defend against a market downturn. Most of my public sector colleagues go 100% equity – after all, their retirement income is virtually guaranteed. But that’s not for me. No thanks. I don’t think I could stomach a 50% drop in my portfolio as well as I think I could.
When I started investing, I had about $48,000 sitting all in savings and $2000 in a lousy mutual fund with a high Management Expense Ratio (MER). My available cash was also growing rapidly due to my aggressive savings rate.
After lump summing the bulk of my $50,000 into consumer-driven stocks traded on the TSX (I don’t index in Canada for reasons I explain here), I was having a hard time figuring out what to do with my leftover monthly income. What I did know was the ideal trading scenario for my savings:
- Obtain exposure to foreign equity markets, namely the S&P 500 and international index funds.
- Trade in the Canadian dollar (CAD).
- Limit monthly trading commissions – I don’t use Questrade for personal reasons.
- Put my money to work almost immediately every month.
Introducing the TD e-series index funds
During my research, namely Canadian Couch Potato, I discovered the miraculous TD e-series index funds. These funds worked just like most index fund ETFs, but rather than being traded on the TSX, they acted more like ultra cheap mutual funds sold directly from the bank. This meant these funds would be subject to a marginally higher MER than an ETF, a 30-day holding period upon purchase, but carry no trading commissions. As an added bonus you could also purchase fractional shares, meaning a $1000 purchase would use the full influx of cash.
As someone who was intending to only put ~$2000 a month in the market on a monthly basis, the product was perfect. I could set up automatic deposits to my trading account and establish recurring purchases of shares on the same day, every month, 12 months of the year. At the time, I didn’t realize what I was signing up to do: dollar-cost averaging.
Why Dollar-cost Averaging is Awesome
Dollar-cost averaging (DCA) is an investment technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. What this means is that if markets are at all-time highs in one month I’m buying less shares. If the market tanks the next month, all of a sudden I’m buying way more shares at a better price. By doing this over a prolonged timeline, I’m effectively getting the average price of the market at any given time.
It is important to note that most literature out there proves that lump sum investing outperforms DCA’ing. I am not disputing this. My endorsement of DCA’ing stems from what to do when you’re saving small amounts of money per month and want to put it into the market rather than let it sit in a savings account. If you have $10,000 sitting in cash, by all means, lump sum it!
DCA’ing mitigates downside risk
When I was younger, my greatest fear of the stock market was putting money in and watching most of it disappear overnight. With DCA’ing, this fear is gone. By always buying, I never have to worry about when the market is expensive or when the market is cheap. If the market skyrockets one day, I’m in great shape because I’m already holding shares. If it tanks, even better, I’m buying the index at a massive discount.
DCA’ing mitigates currency risk
The strong Canadian dollar (‘loonie’) right now sucks for my index funds. For example, my S&P 500 index fund has all of its holdings in USD and any returns are converted to CAD. This means that whenever the loonie goes up, my returns will shrink because every Canadian dollar costs more USD than before.
A friend of mine told me his strategy of waiting to buy foreign equities until the strength of the loonie got to a point where it made sense to convert his CAD to USD. That’s a fair point. If the loonie ever hits par with the greenback again, there’d be no better time to enter the US stock market and I’ll be first in line with him, but doing so eliminates the ability to remain well diversified. Similar to avoiding the stock market until a recession, avoiding trading in foreign equities until there’s a favourable exchange rate can hamper long term returns since your cash sits idle. If you buy at the same time every month for an extended period of time, you’ll be buying stocks when the loonie is both at par and when it’s struggling.
Automatic DCA’ing numbs human emotions
Twice a month, shortly after paycheck day, $1000 flows out of my checking account and straight into the S&P 500 index and international index. It’s so automatic that I’ll sometimes forget that it happens.
While this automatic trading occurs, I’m usually either reading about markets hitting all-time highs or encountering unfavourable pullbacks due to global tensions, trade agreements, and unpredictable presidencies. In any other scenario where I’m submitting my own fill orders, I’m questioning myself on whether or not I should buy at this particular price. When it’s automatic, the hassle of calling my broker to cancel an order is deterrent enough for me to just let it happen.
DCA’ing basically eliminates the question of “what if I’m wrong?” when I buy equities. I don’t stress about day-to-day fluctuations in the market because they become irrelevant the more I buy.
DCA’ing Works for My Risk Appetite
Warning signs in the market will never go away. There will be literature that will tell us a recession is coming tomorrow, just as there will be literature saying the market is set to hit all-time highs.
You can do your best to time the market, but as many finance professionals will tell you, time in the market is more important than timing the market. Personally, I think DCA’ing does both: you’re in the market as soon as you have free cash and you time the market at consistent regular intervals. How could it be better?
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