Putting a new twist on Dollar Cost Averaging

Smart Dollar Cost Averaging

Trying to understand the mass psychology and behaviour of the markets can help us make better investment decisions. We have all heard of the idea of buy low sell high, but how do we figure out when to do it. Most investors tend to dislike losses far more than gains and tend to stop out and lock in losses when they should be buying. Here is one idea how a simple methodology can flip the psychology of fearing high volatility and make it work for you.

We took the simple broadly implemented dollar cost averaging methodology for investing and compared it with a smart dollar cost averaging approach that would buy low rather than buying on a specific day. For this example we used month end contributions but we could have used any day of the month with similar results.

Recall that a high volatility VIX reading of 25 implies a daily trading range of 1.57% according to the math behind the calculation: 1.57%=25/SQRT(# 252 trading days in year). As it turns out, over the past 5 years, there were 64 days where we saw a 1.57% decline or more in the S&P 500. So we took our $12,000 annual contribution and put that money to work at the end of the days where the market was down versus buying only at month end. From 2011 to 2015 following that methodology we outperformed the month end auto purchase by 18.9% over the 5 years.

Watch now: http://www.bnn.ca/Video/player.aspx?vid=799370

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