So, You’ve Got Way Too Much Cash, But the Market Has You Spooked? What Can You Do?
With Americans stockpiling record levels of cash amidst a market wrought with uncertainty, it’s nearly impossible to determine exactly when to get those assets reinvested. As fiduciaries, we do not attempt to “time” the market. Not only is it impossible to pinpoint the market’s peak, it is also equally daunting to identify it’s bottom. So, what do you do if you have an excess of uninvested cash? In this blog we’ll detail one of the most popular strategies for investors big and small – Dollar Cost Averaging or DCA.
DCA is a disciplined approach to market entry where an investor deploys a fixed portion of their idle cash at regular intervals over a period of time, regardless of the price of the investment. This means that the investor buys more shares or units when the price is low and fewer when the price is high. To achieve the intended result, it is important that each tranche of investment be comprised of the same set of securities.
When we recommend that clients consider a Dollar-Cost Averaging strategy, we do so for the following reasons:
(THE BIG ONE) Reduces Timing Risk: Timing the market is notoriously difficult, even for professional investors. Committing to a fixed schedule and spreading your investment portfolio implementation over an extended period means that you are less exposed to sudden market fluctuations and less likely to be affected by short-term price movements.
Builds Discipline: By committing to investing on a fixed implementation schedule, you are creating a habit that can help condition you against the negative behavioral investing tendencies associated with daily market fluctuations.
Can Lead to Better Long-Term Returns: DCA allows you to buy more shares when prices are low and fewer shares when prices are high. Over time, this can lead to better long-term returns as you are buying more shares at a lower average cost.
Peace of Mind: Investing can be stressful, especially in uncertain market conditions. Abiding by a DCA strategy can take the burden of daily market assessment out of your hands.
While what I have described to this point sounds all well and good, I would be remiss to not mention the potential risks associated with a DCA strategy:
Potential For Underperformance in a Bull Market: Logically, if the market and your selected investment portfolio continually appreciate over your DCA period, the portfolio will perform more poorly than if you had invested everything up front. This is why it is critical to consult with your financial advisor and discuss economic indicators, investment expectations and your tolerance for risk prior to commence your implementation strategy.
Overly Rigid Execution: While the purpose of dollar-cost-averaging is to remove emotional investing and reduce timing risk through discipline, that does not mean that you should cast aside all consideration of market performance over the planned investment period. If you buy into a DCA approach too heavily and refuse to react to seismic market events, it is possible to miss out on substantial performance. For example, following the COVID crash of 2020 the S&P 500 took only 5 months to return to all-time levels. If you were in the midst of a long-term DCA strategy in March and failed to react (and accelerate your investment timeline) you would have likely missed out on some sizable gains.
If a dollar-cost averaging approach sounds like it may be suitable for your circumstances, reach out to your investment advisor to assess whether such a strategy does align with your best interest. It’s not flashy, nor is it complex, but it often does provide value to investors with dry powder and that’s what really matters!
