What is dollar-cost averaging?

If you have funds to invest in the equity market, you may worry about buying at a short-term market high. While equity prices do tend to increase over the long term, they typically experience up-and-down movements along the way. Dollar-cost averaging is a long-term strategy that takes advantage of market volatility and price fluctuations to potentially lower the average cost of investment units. It also reduces the temptation to buy high and sell low and helps establish good saving habits.

A fixed-dollar amount is invested in the same equity investment on a regular basis. 

Fixed-dollar amount 

Investing a fixed-dollar amount allows you to get more shares or units when prices are low and fewer shares or units when prices are high. This can lower the average cost for an investment with a price that moves up-and-down but over the long term is increasing. 

Same equity investment 

To be effective, you must buy the same equity investment each time to take advantage of market volatility. If you alternate investments as part of the strategy, there is the risk that you buy at the high of each investment. 

Regular intervals 

You can make purchases weekly, biweekly, monthly or quarterly, although more frequent purchases decreases the impact. The important point is that you invest at regular intervals — regardless of the market price of the shares or units.

You must stick with it especially if prices fall and remain low for a period of time. In theory, when you sell the overall investment years later, the market price will have risen, and you will realize a gain. However, as with all equity investments, there is no guarantee of gains. If you accumulate units at a price higher than they are sold for, you will experience a loss. This is why dollar-cost averaging is a long-term strategy that works best with investments that are viewed as having long-term growth potential. 

Example:

In this simple example, the average price per share/unit over the 3 months is $10. However, the average cost per share/unit to the investor is less — only $8.20 (total amount invested divided by the total number of shares/units). This is because the person invested a fixed-dollar amount, so they bought more shares/units when prices were low and fewer shares/units when prices were high. Remember, dollar-cost averaging is a long-term strategy.

As part of the  dollar-cost averaging strategy, you can set up a RIP to have automatic debits made from your bank account to your CIBC Investor’s Edge account and either have the money automatically invested in a mutual fund or use the cash to purchase other types of investments such as stocks. The strategy can be carried out in both non-registered and registered accounts.

It’s easy to set up a RIP online at CIBC Investor’s Edge. Simply sign on to your Investor’s Edge account, visit the Trading page, select Regular Investment Plan and follow the instructions. You’ll be asked which bank accounts you want to withdraw from and deposit to and when you want the RIP to start. You’ll also be asked how much you want to withdraw or deposit, how often (e.g. monthly, bi-monthly, etc.) and what type of plan — mutual fund or cash — you want.

With a mutual fund RIP, your regular deposit or a contribution will be automatically invested in a selected mutual fund. You can also have the dividends reinvested in the units of the same mutual fund or get the cash deposited to your investment account. One more benefit is that there is no commission associated with mutual fund trades through a RIP.

You’ll need to set up a cash RIP to buy investments other than mutual funds, such as stocks. With a cash RIP, funds will automatically move into your securities account but you must enter the trade order yourself each time. Don’t forget that you’ll pay trading commissions on these transactions.

Start now 

One of the advantages of dollar-cost averaging is that it doesn't matter when you begin, since you won’t be making a large, one-time investment at a market high.

Consider using for RRSP, TFSA or RESP contributions 

Rather than making one purchase a year, which is often done close to the deadline, you can follow the dollar-cost averaging strategy within a Registered Retirement Savings Plan (RRSP), TFSA or Registered Education Savings Plan (RESP) by using a RIP.

Note that when you make a qualified contribution to an RESP, you may be eligible to receive a grant for that contribution. You can then invest that grant and receive growth earlier than if you had waited until the end of the year to get it. 

Bottom line

Using a dollar-cost averaging strategy can help lower the average cost of your investments. Coupled with an easy-to-implement mutual fund or cash RIP, it may help grow your returns over the long term.