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Investing

December 08, 2014

Today’s TSX decline highlights value of disciplined investing

The Toronto Stock Exchange dropped almost 460 points, or 3% of its value, this afternoon – one of its sharpest one-day declines since 2011.

While it rebounded somewhat from this low, the market was still down 329.53 as of close of trade.

What does this mean for investors? First of all, stock market volatility is a reality that needs to be carefully factored into any long-term savings strategy. It also reinforces the value of dollar-cost averaging (DCA) – buying a set dollar amount of a security at regular intervals to help promote disciplined investing (as opposed to trying to second-guess where the market is headed).

“At its core, dollar-cost averaging is a savings discipline,” says Michael Nairne, a certified financial planner and president of Tacita Capital Inc., a private family firm in Toronto. He sees it as a form of paying yourself first.  While you’re building your wealth, he says, “the rate of saving is generally more important than the rate of return.”

For Mal Spooner, corporate finance professor at Humber College in Toronto and author of A Maverick Investor’s Guidebook, DCA is a hedge against the common tendency among investors to buy high and sell low, robbing themselves of profits. “Everybody wants to invest aggressively when markets are going up,” Spooner says. “DCA forces you to buy when markets are bad as well as good.”

A regular commitment

By committing yourself to invest a set amount regularly (say, $1,000 once a month), regardless of whether the market is up or down, you end up buying more when the market is down and an investment is cheaper, and less when it’s up and an investment is more expensive.

As a general example, let’s say you’ve decided to make a long-term investment in ABC Mining (ABC), which is trading at $50 a share. In month one, your $1,000 purchase gets you 20 shares. (For simplicity’s sake, let’s ignore transaction costs.) Then environmental concerns put a damper on mining stocks and ABC drops. When it’s time to buy in month two, ABC is trading at $40 a share and your $1,000 gets you 25 shares. But as your month-three purchase approaches, good drilling results send ABC climbing — to $55 a share. Your $1,000 then gets you only 18 shares. In those three months, you have stayed disciplined about your investing and accumulated 63 shares, at an average cost of $47.62. A market price in excess of that makes your ABC investment a winning one.

Of course, this is oversimplified: DCA is meant to be a long-term strategy and each time you make a purchase you do pay transaction costs. But over the course of your investment, assuming markets trend upward, your DCA strategy should pay off in two ways. Number one: You are building your savings every month. Number two: By staying disciplined, you have resisted the urge to make the kinds of emotional decisions that often result in buying high and selling low.

“It’s behaviourally positive,” says Nairne. “Individuals investing in equities can feel good when prices are falling because they’re buying more. They can also feel good when prices are rising, because the value of their equity is increasing.”

DCA for mutual funds, too

Spooner says the strategy can also be applied to mutual funds. Suppose you have allocated a third of your portfolio to a Canadian equity fund, a third to a Canadian income fund and a third to an international equity fund. Your DCA strategy calls for you to invest $1,000 once a month.

Markets being what they are, chances are, in any given month, one of your funds will be underperforming (not doing as well as the market on the whole), and so your $1,000 investment will buy more units of that fund.

Conversely, this means you will acquire fewer units of the fund that has increased in value. By resisting the temptation to buy more of the better-performing fund, you could escape owning too much of it if and when its performance begins to deteriorate. Over time, your portfolio remains efficiently balanced.

Of course, for DCA to work well, you have to choose good investments, assuming that any downward movement in the share or unit price is the market’s failure to recognize value and the setback is only temporary. The danger arises when setbacks linger for the long term, landing your investment in trouble. Remember ABC? Suppose the drill results didn’t pan out and your shares languished around $20 each. DCA is not going to save a bad investment. It’s vital that you — with the help of an advisor, if you work with one — regularly review and rebalance your overall investment portfolio to ensure it still supports both your risk tolerance and your financial goals.

The information contained in this article is intended for general informational use only and is compiled from sources believed to be reliable, but no representation or warranty, express or implied, is made as to its accuracy. All opinions contained in the article and/or commentaries expressed by Sun Life Financial and/or its affiliates (collectively,"SLF") are subject to change without notice and are provided in good faith without legal responsibility.

This article is not intended to provide specific financial, tax, insurance, investment, legal or accounting advice and should not be relied upon in that regard and does not constitute a specific offer to buy and/or sell securities. Please speak with a professional advisor before acting on any information contained in this article.

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