The Science Behind Wealth
A systematic investing plan provides discipline and the potential for better returns.
Investors who watch the markets closely can get dizzy tracking all the ups and downs – and, as prices fluctuate, often unpredictably, it can be hard to stay focused on long-term plans. When markets drop, it can be very difficult to fight the temptation to sell. When markets rise, it can be equally tough not to jump on the bandwagon and buy. The result, for many investors, is selling low during market downturns and then buying back as the market rises.
Yet a simple strategy can help investors ride out volatility and achieve better long-term returns. A systematic investing plan quite simply means investing the same amount of money regularly, no matter what the markets are doing. When prices are high, that amount buys fewer units. When prices are low, that amount buys more units. The average cost per unit tends to drop over time because the investor buys less at a high price and more at a low price – which is why this approach is also known as dollar cost averaging.
How it works
Here’s a simple example that shows how a systematic investing plan can benefit an investor. Let’s say Janice commits to investing $100 in an equity mutual fund every week. As it happens, the equity markets are especially volatile over the next two months:
Over the eight weeks, Janice invests a total of $800 and buys a total of 86.4 units. Her average cost per unit is $9.26. Had Janice invested her entire amount of $800 during week 1, her average unit cost would have been $10.00 versus the weekly investment strategy where her average unit cost was $9.26, a savings of 0.74 cents per unit.
In hindsight, she could have done even better if she had somehow known that week 3, when the cost per unit was at its lowest, would be the best time to buy. In that case, her $800 investment would have bought 114.3 units, worth $1,028.70 in week 8. However, she could also have done much worse if she had wrongly guessed that week 6, when the cost per unit was at its highest, would be the best time to buy. In that case, her $800 investment would have bought just 66.7 units worth $600.30 in week 8.
But not even the most skilled professional investors can say with certainty when the equity markets have bottomed out or peaked, so a systematic investing plan is a more disciplined approach than attempting to time the markets. By averaging out the cost per unit over time, and ensuring fewer units are purchased at high prices, systematic investing can help investors achieve greater potential capital appreciation, aligned to the mantra “buy low, sell high”.
Why it matters now
We may be entering a period of increased market volatility in the coming months, with global economic growth slowing and the possibility of a global recession on the horizon. While some investment strategists don’t think the equity markets in Canada, the United States or around the world are overvalued, relatively, economic slowdowns tend to weaken earnings growth, which may put pressure on stock prices.
Investors who are supported by the discipline of a systematic investing plan may be better able to take the long view through volatility. Perhaps the best thing about a systematic investing plan is that it’s automatic and unemotional, helping investors avoid the biases that affect us all and can lead to costly investment decisions. Instead of selling when prices are low, or “on sale,” investors with a systematic plan keep buying in all market conditions. Just as important, instead of missing the best days of a recovery because they’re out of the markets, those investors remain invested, leading to a potentially better outcome.
“Cognitive biases are an evolutionary adaptation. Our brains have evolved to have a very fast, non-analytical way of thinking. When confronted with danger, it doesn’t make a lot of sense to sit down and analyze what to do. It usually makes more sense to just do anything rather than deliberate.”
— Dr. David Lewis, PhD, Chief Client Officer, BEworks
A systematic investing plan takes the emotions and guesswork out of investing. Rather than spending time and energy trying to work out when to buy and when to sell, investors are always buying, a little at a time, knowing that every investment brings them closer to their long-term objectives.
Discipline is what it takes to block out the noise, commitment is what it takes to walk the path to financial success and patience is what it takes to reach the goal.