When stock markets fall, many of us are tempted to sell, or buy. What we all need to realize is, if we try to time the market by buying low/selling high, it could cost us more than just staying invested. For one simple reason, if you try to predict the market, you might miss out on the best days. Historically, when markets recover, it often happens suddenly, and leaves little time for investors to react.
Consider some poignant numbers from this hypothetical example:
Suppose an investor invested $10,000 in the S&P/TSX stock Index for twenty years, from January 1, 2003 to December 31, 2022.
If she left it there for the entire twenty years her $10,000 would have grown to about $50,000.
If she had taken her money out once in a while, and missed the ten best days, her $10,000 would have grown to $25,000, half as much.
And if she happened to miss the twenty best days, because she was weaving in and out of the market, her $10,000 would have only grown to $16,000, a lousy return on investment.
The point is clear. Trying to time the market by selling and buying carries the risk of missing out on the good days, thereby achieving lower returns. So what’s an investor to do?
There’s a better way to deal with market fluctuations, and that’s with a well proven strategy called Dollar-Cost Averaging (DCA). It’s a very simple strategy to follow. With DCA an investor buys a fixed dollar amount of an investment at regular time intervals – say on the fifteenth of each month.
So, let’s say you buy $1,000 worth of units of the same investment every month. With fluctuations in the marketplace, sometimes the cost per unit will be higher, and sometimes it will be lower. When the price is lower your $1,000 will buy more units, and when the price is higher your $1,000 will buy fewer units.
Over time, it works out that your average cost per unit is lower than the average market price. This adds to your rate of return, lowers your risk, and does away with the problem of trying to speculate when to buy and when to sell.
DCA is a disciplined approach that can nicely fit in with your financial plan. DCA helps make sure that you don’t try to time the market, and that you continue to invest even when the markets are down (taking advantage of the opportunity to invest at lower prices).
DCA gives you peace of mind. Regular contributions means not having to worry about investing at a high point in the market, or missing out on an opportunity to invest at low prices.
Is Dollar-Cost Averaging right for you?
• Yes, if you are looking for an investment strategy that will help provide more consistent returns over the long run.
• Yes, if you want to make regular contributions instead of lump sum payments.
source: Hypothetical example of $10,000 invested for illustrative purposes only from Manulife Investment Management May 8, 2023 blog
