Many people start their investing career through regular contributions. Some people consider this to be dollar cost averaging (DCA), but it's not true to the spirit of what DCA is all about. It's not like you have a choice.
A lot of people delay talking to a financial adviser because they feel that they need to have a lump sum of money before they can start investing. However, before you can become an investor, first you must become a saver. Sometimes the two go hand in hand, like when an adviser sets you up on a PAC plan (pre-authorized contributions) that takes money directly from your bank account, which is used to purchase units of your favourite mutual fund. Over time, your portfolio grows.
This takes advantage of the basic concept of DCA, but not by choice. It's a structural necessity for most people. With DCA, you contribute the same periodic amount regardless of the value of the investment. So if your mutual fund units start the year at $10/unit, you would buy 10 units for January. If the fund fell in value to $9/unit in February, your $100 contribution would purchase 11.11 units. Let's assume that the day before your third monthly contribution, the value of the fund is back up to $10/unit. You have 21.11 units worth $211.10. If you had simply invested $200 in January and bought 20 units at $10/unit, your investment would still be worth $200.
This naturally forces an investor to buy more units when the investment is down and less when the investment is up. But a new investor doesn't really care about that; they are forced into DCA because they are just starting out. They didn't have the option of investing $200 in January because they could only contribute $100 per month.
DCA is a concept that is actually geared toward investors with a lump sum who are trying to figure out if they should buy an investment at today's price or the average price over a period of time in order to mitigate the risk of buying at a peak.
When you are starting out, and your monthly contributions dwarf the monthly fluctuation of your portfolio value, the potential benefits of DCA aren't top of mind. But if you have $100,000, do you just throw it all into the market at once? Or do you space out that deployment just in case the market is volatile or could go down in the near future? That's actually what DCA is all about.
So for new investors who don't have a lump sum to invest, the good news is that you don't need one. You can set up a regular contribution and slowly accumulate a portfolio over time. Some people will tell you about the concept of dollar cost averaging when setting you up on a pre-authorized contribution plan - which is fine. But the true spirit of DCA is going to be much more important to investors with lump sums to be deployed.
Preet Banerjee is a senior vice-president with Pro-Financial Asset Management. His website is wheredoesallmymoneygo.com.