Renowned investor John Templeton is remembered for advocating the ‘principle of maximum pessimism’: “People are always asking me where is the outlook good, but that’s the wrong question. The right question is: Where is the outlook the most miserable?”
In investing, while the concept of buying securities at low prices and selling them at high prices may seem obvious, it may be a lot more difficult for investors to do in practice. Bottoms tend to occur when sentiment is at its lowest, and the natural inclination may be to sell, not buy. As Templeton reminds us, these are precisely the times that can turn out to be some of the most opportune.
For many of us, it’s not easy to commit new funds to an investment during uncertain times. This is where a dollar-cost averaging (DCA) program may be a useful technique. A DCA program mandates regular, modest investments, rather than one major lump-sum commitment. Thus, investors need not focus on thinking about market movements to prompt buying decisions. DCA can also align nicely with personal cash flow, as contributions are made at regular intervals, such as monthly or quarterly. This promotes the discipline of saving on a steady basis. Not only can it remove the emotion from investing decisions and match cash flow, but for longer-term investors DCA can also help to build future returns — even when prices may be falling over extended periods.
How can a DCA program help during down markets? A real-life example (chart) shows the potential impact over a prolonged bear market. It may be hard to remember, but the last sustained S&P/TSX Composite bear market occurred after the dot.com bust of 2000 and lasted 25 months, ending in September 2002.1 The chart uses actual returns of the S&P/TSX Composite Index to depict a DCA program where, each quarter, $1,000 was invested. Despite poor market performance, the DCA program resulted in a modest gain of $1,130 ($17,130 less the $16,000 invested) and, more importantly, the ownership of significantly more units, which benefitted the portfolio as time went on. Given a constant investment amount, consider that you can purchase more units when prices are lower and fewer units when prices are higher. By contrast, had the lump sum investment of $16,000 been deployed at the beginning of the period, it would have returned a small loss, with an overall value of $15,633 and just 1,902 units owned compared to the 2,084 units under the DCA program. During times of uncertainty, DCA may be a useful strategy for some investors to take the emotions out of investing while continuing to put money to work. DCA is a good reminder that a thoughtful investing plan can result in positive progress toward achieving wealth- building goals, even during down-market times.
1. Of over one year. The last bear market during the pandemic lasted less than two months. The prior bear market of 2008/2009 during the Global Financial Crisis was only nine months long.