Investment Workshop 07: Dollar Cost Averaging

So here we are. We’ve chosen our asset allocation, we’ve picked our ETFs, we’ve decided on our asset weightings, and today we sit here on the precipice, ready to make our first investment and put our money where our mouth is. But…is now the right time to do it? The news is a constant stream of confusing and scary events. There’s conflict in the Middle East! There’s another election around the corner! Experts are saying the stock market is overbought and a recession is coming any day now!

OK here’s the thing: We’ve been investing for over a decade now and whenever it comes time to commit any amount of money to any investment, the markets are in either one of two states:

  1. The market is crashing. You’d be nuts to invest now.
  2. The market is flying way too high and a crash is around the corner. You’d be nuts to invest now.

That’s it.

Those are the only two situations that exist when it comes time to invest. The stock markets have NEVER, and will NEVER be in a state of “Everything looks fine, so now’s a good time to buy.” It’s always in a state of disaster, or with a disaster right around the corner.

And those predictions, by the way, have always always ALWAYS proven to be wrong in the long term.

So how to invest in such treacherous times?

Simple. Dollar Cost Averaging.

What is Dollar Cost Averaging?

Dollar Cost Averaging (or DCA, as the cool kids call it) is simply the process of spacing out your purchases to happen periodically over time. So for example, instead of investing $100k all at once, maybe you do it in 12 equal instalments once a month. This does two things.

  1. Dollar Cost Averaging takes emotion out of your investment decisions, and emotion is your single worst enemy when it comes to investing.
  2. Dollar Cost Averaging allows you to slowly ease into the process of investing gradually rather than be forced to take one giant scary step.

The debate of DCA vs Lump Sum Investing is one of the few points of disagreement I have with J.L. “The Godfather” Collins, who described DCA in our last conversation as “changing your investing to match your psychology rather than changing your psychology to match your investing.”

However, I think that Dollar Cost Averaging is the way to go for most people because it addresses the biggest problem people have when it comes with investing: Fear of the Unknown. That’s what this entire Workshop is about. Addressing people’s Fear of the Unknown. It doesn’t matter how many articles someone reads about how statistically safe skydiving is, they’re still going to be scared shitless when they stand at the edge of that airplane door for their first jump.

Yes, the news is volatile and unpredictable, but the news is always volatile and unpredictable. When we first wrote this Workshop, it was 2016 and Trump had just been elected. Everybody was predicting a stock market crash, and of course the exact opposite happened.

In the short term, always expect that your portfolio may go negative. And as we discussed previously, how negative it can go is determined by our initial equity allocation decision. For a 60% equity 40% fixed income portfolio, we can expect a worst-case decline of around 20%. If you aren’t OK with that, lighten up your equity weighting.

However, that is exactly why we are investing using DCA. In a stock market crash, DCA will allow us to pick up more units at a cheaper price and ride the inevitable recovery even stronger. It’s what allowed us to escape 2008 without losing any money and it will work again here if that happens.

So to be clear, when investing in the stock market using Index ETFs, you can expect:

  • Your portfolio will be down at some point
  • Your portfolio will not go to zero
  • If you are down, your portfolio will eventually recover
  • Over the long term (10 – 15 years), you will likely make around 6-8% annually. More if you have a higher equity allocation.

Creating a Buy Schedule

The length of your buy schedule depends on your outlook of the stock market. If you think markets are fairly priced or even underpriced, a short buy schedule of month or two would be right for you. If you think markets are headed for a downturn, lengthen out your buy schedule to how long you think the downturn will last. However, don’t make your buy schedule longer than a year, because then you risk just sitting on the sidelines forever and never getting started.

Once you’ve decided on your buy schedule, divide up the cash you intend to invest by the number of months in your schedule. If your buy schedule is six months, then divide by six. If it’s a year, divide by 12.

Then, at the beginning of each month, transfer that month’s worth of cash into your investment accounts. You need to do this regardless of whether stock markets are up or down that month. In fact, you especially want to do it during a down month, because by buying when markets are low, you’re picking up units on sale, and more units you pick up when they’re cheap, the more you’re benefit when markets inevitably rebound.

This is basically how we were able to ride out the 2008/2009 market crash without losing any money.

After your initial cash investment is deployed, just align your buy schedule going forward with how often you get paid.

Remember, consistency is key. By doing it regularly and repetitively regardless of what happens in the news, you’ll make investing into a habit, and once it’s a habit, you’ll keep doing it. Time in the market is more important than timing the market.

Conclusion

So that’s it on dollar cost averaging. Stay tuned for our next exciting instalment of the Investment Workshop!

Onto the next section!

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WORKSHOP TOOLS

How much does it cost to participate in the Investment Workshop? NOTHING. Because that's how we roll. All we ask is that you sign-up using the following affiliate links to keep it free forever:

For Canadians:

1) Questrade

2) Passiv

For Americans:

1) Vanguard

2) Empower



Disclaimer: The views expressed is provided as a general source of information only and should not be considered to be personal investment advice or solicitation to buy or sell securities. Investors considering any investment should consult with their investment advisor to ensure that it is suitable for the investor’s circumstances and risk tolerance before making any investment decisions. The information contained in this blog was obtained from sources believe to be reliable, however, we cannot represent that it is accurate or complete.


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