By Scott Ronalds

Flashback to October 2014. The Canadian stock market (S&P/TSX Composite Index) just turned in a 1-year return of 20%, the global market (MSCI World Index) was up 23%, and the Canadian bond market was up 6% (as of September 30th). Stock markets in general had been on a roll over the past five years. But geopolitical tensions were heating up, the price of oil had just dropped 15% over the summer, stock valuations were reaching expensive territory, and some investors – including us – were calling for caution.

Paul, a Steadyhand client, was due to receive $300,000 before year-end from an inheritance and didn’t know what to do with the money.

Reality Check

Paul's intention was to invest his inheritance in the Founders Fund, according to his long-term plan, but he was wary of the markets. He laid out three options:

  • Invest it all at once by the end of the year;
  • Phase it in over time;
  • Keep it in cash until things cool down.

It was a decision he was losing sleep over. Coming into a large sum of money can be a nice problem to have, but can also come with a lot of stress. What would you have done?

Phasing it in

Paul decided to phase the money in, through a dollar cost averaging plan. He committed to investing the $300,000 in four tranches ($75,000 on December 31, March 31, June 30 and September 30). His decision provided him with some comfort knowing that he wouldn’t invest all the money at once at a potentially inopportune time. But he would only know in hindsight whether his returns would be better, or worse, as a result of this strategy.

In our view, Paul could have gone with the first or second option, but we advised him against sitting in cash and waiting for a better entry point. Nobody knows what will happen in the markets in the short term, and picking an entry point can be an extremely difficult decision emotionally.

The Result

With the last tranche passed, Paul’s money is fully invested and we now have the benefit of hindsight when evaluating his return. His investment was worth $295,724 as of September 30th. If he invested the money in a lump sum on December 31st, it would have grown to $303,965. (Note: Our calculations do not factor in fee rebates based on the size of the investment, which would have increased the return in both instances).

Paul’s decision cost him in the form of a lower return (in fact, a negative return), but it provided him with peace of mind, which is a tradeoff that some investors are fine with.

Dollar cost averaging won’t always produce an inferior return to a lump sum investment. In a steadily declining market, it will produce a better result.

Paul’s dilemma is one we encounter often. Because of the emotional benefit that dollar cost averaging can provide, it can be a valuable strategy for some investors. That said, markets rise more frequently than they fall and studies have shown that investors are typically better off going with a lump sum investment approach. If one thing’s for certain, it’s that either approach beats sitting on the sidelines indefinitely.

Management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. The indicated rates of return are the historical annual total returns including changes in unit value and reinvestment of all distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns.

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