Combine a Systematic Savings Plan with Dollar Cost Averaging to take advantage of market volatility and remove “timing the market” decisions.

We all have read the importance of starting a savings plan early, especially when considering your long-term goals like ‘freedom’ (aka retirement, being able to work when you want and how you want).  There are many financial tools online to illustrate the specifics – how much you need to save over what period of time, at various projected return dates.  (As a matter of fact, I wrote about this and gave some examples in a previous post.. “Tic-Toc – When It Comes to Savings, Time is Money“.)

The stumbling block for some is not saving, it’s the investment side of things.  Why? We are inundated daily with conflicting viewpoints on market direction, analysts squaring off against each other, headlines talking of corrections and markets gyrating back and forth throughout any given day.  Information has never been so readily available in whatever medium – and together all of it can cause overload…an analysis paralysis if you will.

The chart below, from visualcapitalist.com, reveals that while 87% of Millennials are confident to make investment decisions, a whopping 70% are holding their investments in cash.  Perhaps this is a fear of market volatility, but perhaps even more is the pressure of timing the market in volatile times – how do you know the good day to buy low?

Investing is emotional – and often with everything else we have going on our day to day life, the extra turmoil is overwhelming.  So it’s easy to put off for another day.   Staying on the sidelines in cash presents another type of risk – cash does not protect against inflation thus eroding purchasing power, nor does it provide any long term growth.

A solution? Given our penchant for all things electronic and automatic, the strategy of combining a systematic savings plan with a Dollar Cost Averaging investment approach will automate the savings process – and remove the decision of market timing.  Think about it – rather than having to keep thinking of how much you need, how much to contribute and when to invest, you set it up and it’s just done.

I can’t resist one visual on the growth of money over time – words describing how your money works for you over long periods of time is one thing, but seeing it is another. The chart above is based on the long term historical real return rate average of 6.9%, and illustrates the positive impact of saving early, allowing time for growth to compound.  Just have a look at the difference between the growth of a dollar over 15 years vs 25 – the end result is almost double!

So, now that you’ve determined it’s time to get started, the first step is to arrange a systematic withdrawal plan through your bank, brokerage firm or online broker for deposit directly to your non-registered or registered accounts. These deposits can be arranged at the frequency that best suits you – a monthly plan on a set date often is a good place to start. Remember, the amount can be adjusted in future, so start with a number that is achievable within your budget and in line with your goal.

Next, it’s onto having the investing on auto-pilot:  using Dollar Cost Averaging, the purchase of your investments can be coordinated with your deposits into the account – matching frequency and having your savings start working for you right away.  Investing at regular intervals will result in a variation in acquisition cost with market fluctuation – sometimes your deposit will buy less number of shares or units and other times, more – thus averaging your cost base.  The following chart illustrates a monthly deposit of $300 covering the purchase of 10 to 30 shares, depending on the price per share at the time of purchase.  Sure, if you called the bottom in February you could have invested a lump sum and bought shares at the low of $10.  However, you could have just as easily invested the lump sum in $30 shares in January.  Dollar Cost Averaging takes the guessing out of ‘timing the market’, replacing it with ‘time in the market’ – smoothing out the price fluctuations over time and keeping your money invested.

Dollar cost averaging

Keeping on the topic of market timing, I couldn’t resist sharing the following chart which illustrates the negative effect of trying to time the market.  The pitfalls of trying to time the market are quite simply missing out because of the uncertainty of when to invest a lump sum (waiting with cash), or deciding when to re-enter the market after an exit.

Historical returns vs market timing

Being on the sidelines for any reason can be costly as seen above.  And potentially time consuming and stressful :).

The next step – what investment vehicles to allocate your savings into each month. Individual shares? Mutual Funds? Low cost ETFs?  This aspect is one that deserves a chart – simply because, like timing the market, it is very difficult to predict with certainty what asset classes, economies, sectors of the market will outperform in any given year.  The chart below illustrates just that – often the previous year’s winners become the following year’s losers – look at the emerging market’s (in pink) see-saw performance in 2008 and 2009 after the consistent run starting in 2003.

Asset Class returns to 2015

More than anything else for me, this chart illustrates the importance of not putting your eggs in one basket:  diversify.

While a Dollar Cost Averaging strategy will work with individual company shares, mutual funds or ETF’s, consider the costs of placing your trades when you choose.  Some investment companies offer a selection of mutual funds and ETFs that can be bought without commission or up front fees, making them an ideal choice for diversification and cost-efficiency.  That being said, do your homework when making your investment selections, or work with a financial advisor to discuss your risk profile, goals, and appropriate recommendations.

Once the savings and investment plan is in place, it is time to let it do its thing.  Give it time to work, to grow.  We are so used to immediate information and immediate results that sometimes, especially when listening to the media about market fears, we feel we have to act/react, when the best course of action is to do nothing at all,  except remind ourselves to stick with the plan that was made after careful consideration, risk assessment, and identifying our goals.  Growing a portfolio is somewhat like planting a garden or baking a cake – it needs the time left alone to work, without continually pulling up roots or opening the oven door.  Annually, or semi-annually, have a look at your investment plan or meet with your advisor to assess whether any changes are needed.  Then sit back and relax.

The not so fine print:  Please note the author is not a Registered Investment Advisor, Broker/Dealer, Financial Analyst, Financial Bank, Securities Broker or Financial Planner. The above information is provided for information purposes only. The Information is not intended to be and does not constitute financial advice or any other advice, is general in nature and not specific to you.  Rates of return used in projections do not imply a guaranteed rate of return, actual return will vary with market fluctuation.  None of the information is intended as investment advice, as an offer or solicitation of an offer to buy or sell, or as a recommendation, endorsement, or sponsorship of any security, Company, or fund.  You are responsible for your own investment research and investment decisions.