Most Canadians who can invest, invest when they can.
It’s often done as a lump-sum payment to beat the annual registered retirement savings plan (RRSP) deadline each March, but that presents the risk of buying when markets are at their peak.
One way to mitigate that risk is through dollar-cost averaging (DCA)
DCA: set it and forget it
DCA involves investing throughout the year at regular intervals.
Investing regularly averages out entry prices and reduces the impact of short-term market downturns. It lowers the average cost because your money buys more shares or units when markets are down and fewer when they are up.
DCA investing is a safe way to build a portfolio over time. It’s one of those ‘sleep at night’ things.
Individual investors can dollar-cost average by setting up automatic monthly or weekly withdrawals through their financial institution.
Working Canadians could be DCA investing each pay day through their defined contribution pensions, along with matching contributions from their employers.
Lump-sum investing: risk and reward
Not all lump-sum investing is done by people trying to beat the RRSP deadline.
Holding a large sum of cash presents an opportunity to strategically time the market for low entry points. Famed value investor Warren Buffett has mastered ‘buy low, sell high’ with a focus on corporate earnings, but there is an endless array of techniques to gauge how specific investments will react to market forces.
If the value of the investment goes lower in the short term, the value investor with conviction will buy more and lower their average cost.
Warren Buffett proves timing the market correctly can pay off in a big way, but losses can be huge if that low point continues going lower.
What the data reveals
Broad equity markets have always gone up over the long-term and that’s why lump-sum investing reaps better results than DCA investing over longer periods.
Lump-sum investing generates higher returns than DCA 66 per cent to 75 per cent of the time, according to a recent study by RBC Global Asset Management.
It measured average returns from both strategies over monthly time periods ranging from three to 12 months in each consecutive year since 1990.
It compared a one-time, lump-sum investment of $10,000 made at the beginning of each time period with DCA installments of $10,000, spread out evenly each month over the course of each time period.
In each time period, the lump-sum strategy came out on top because markets generally rise over time and the DCA investor often bought in at higher average prices.
Strategic investing
Of course, lump-sum investing results can vary widely based on investment skill and just plain luck.
One idea to combine the safety of DCA with the opportunity potential of lump-sum investing is a hybrid strategy that includes both.
That means you might need to bank up cash for when the time to buy is right. Most investment advisors recommend ten per cent of a portfolio be set aside in a high-interest savings account.
It’s important to know that regular cash contributions to RRSPs and tax free savings accounts (TFSAs) can remain in cash and invested whenever you want.
In other words, they can be deployed immediately or set aside for bargain hunting later.
