7 ways to make the most of dollar-cost averaging
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Market fluctuations make it difficult for most investors (and even some professional managers) to determine precisely when to capitalize on an investment.
However, there is a useful investment technique called dollar–cost averaging.
With dollar-cost averaging, you invest a fixed-dollar amount at regularly scheduled intervals, while also taking into account market fluctuations.
But what does this mean exactly?
Well, think of dollar-cost averaging as a ‘market volatility alarm clock’ for your investments.
When the unit price is high, your fixed investment will buy fewer mutual fund units. When the price drops, it will, in turn, buy more units. In doing so, your average unit cost will be lower and you will be eliminating the risk of investing in the market at the wrong time.
Plus, the longer you choose to take advantage of dollar-cost averaging (such as a period of 5 to 10 years), the more lucrative it will prove to be.
Can this investment strategy really lower your investment costs and reduce the impact of market volatility on your portfolio?
The answer, in short, is yes.
However, to truly maximize its benefits, here are 7 ways to make the most of dollar-cost averaging:
1. Start using this strategy as early as possible.
Dollar-cost averaging instills the practice and discipline of investing regularly. The earlier you learn this particular lesson, the greater the potential for gain over the long term.
It’s also effective, even if you can only afford to invest smaller amounts—making dollar-cost averaging a very practical strategy at the start of your education career (when you’re typically lower on the pay grid).
2. Invest consistently.
Whether investing a set dollar amount or a percentage of your income, Educators Certified Financial Planner, Mike Cunningham, recommends doing it the same way every time.
“One of the things that makes dollar-cost averaging effective is the consistency”, says Mike. “So, pick how you want to invest, whether that be weekly, monthly, or quarterly—and stick with it. Otherwise, you’ll end up saving at different ratios, which will cause inconsistent returns over the long term.”
3. Remember to rebalance your portfolio.
Together with your financial specialist, you’ve worked hard to determine the right mix of investments in your portfolio (also known as its ‘asset allocation’).
Just keep in mind that different investments will grow or decline at different rates.
One year may be good for stocks and bad for bonds—the next year, vice versa. The different parts of your portfolio will also grow at different rates. To compensate for the natural ups and downs of the market (and keep your original asset allocation), your portfolio should be rebalanced to reflect its original target at least once a year.
4. Keep calm and carry on (with dollar-cost averaging).
It may be tempting to abandon this strategy when the market gets turbulent. But resist the urge to pull the plug. Doing so means inadvertently going back to trying to time the market—exactly what any financial advisor would advise against.
5. Remain engaged.
Just because you’re committed to a strategy doesn’t mean you stop being involved.
For example, some investors establish a ‘stop-loss order’ to sell an investment (an order that’s put in to automatically sell a stock when an investment drops by a predetermined amount). However, a stop-loss order is more appropriate if you are buying shares of a stock, rather than investing in a dividend-producing fund or exchange-traded fund.
Moral of the story: keep your eye on the ball when it comes to any investment strategy.
Don’t have time to be constantly checking in on your investments? Educators Monitored Portfolios are the solution.
6. Have a lump sum to invest? Treat it differently.
If you should find yourself coming into a large sum of money that you want to invest (I.e. through an inheritance), don’t take more than a year to invest it. Studies have shown that a lump sum invested all at once tends to produce higher returns (about two-thirds of the time) than money invested in 12 monthly installments.
Keeping cash on the sidelines for too long could mean missing out on potential gains from putting those dollars to work.
7. Be aware of costs.
Because dollar-cost averaging requires buying units regularly, trading and transaction fees can add up. You can find out more about the costs of investing in mutual funds in The Learning Centre.
When you’re an education member, the best way to make the most of dollar-cost averaging (or any other investment strategy) is to speak with Educators Financial Group.
From where you are on the pay grid, to how much pension income you bring in during retirement—we offer a genuine understanding of your finances. This means getting investment advice that truly factors in your unique financial situation, no matter what career or life stage you happen to be in.