The Canadian, US and international markets all fell more than 5% last week, the sharpest weekly drop we’ve seen in almost four years. Then on August 24, global markets plunged even further. If you were waiting for a pullback to give you a buying opportunity, you just got it. But if you’re sitting in cash and paralyzed with fear, you’ve just learned how you can get into trouble when you invest without a plan.
Let me be clear before we go further: I’m not recommending that investors hoard cash and wait for big drops like this one. Let’s remember that the last time we saw a sharper one-week decline was September 2011. The opportunity cost of being uninvested—even for a couple of months, let alone four years—can be enormous. So if your savings are coming from a regular paycheque, you are better off setting up an automatic investment plan that removes the emotion from your decision making.
However, If you recently came into a large lump sum—from an inheritance, the sale of a property or business, or a pension payout—things are a little different. You are still likely to be better off investing the lump sum immediately rather than spreading it out over a year or two: studies have consistently shown that the all-in move delivers better results about two-thirds of the time. But investing a huge chunk of cash is stressful, so it’s perfectly reasonable to accept a lower expected return in exchange for avoiding enormous regret.
But here’s the thing: dollar-cost averaging—or investing the lump sum gradually—sounds much easier than investing a lump sum. However, when it comes time to actually make each of those trades, you are still going to feel anxious. Indeed, dragging out the process over a year or more may actually be harder—like wading slowly into a cold lake instead of just taking the plunge.
One tough decision becomes many
I just heard from an investor who planned to invest his cash in two tranches: he put the first half into the markets in early July and planned to invest the second half later in the summer. But as prices continue to drop, he’s changed his mind. That money is still sitting in cash as he waits for “the right time.”
Let’s think about this decision for a moment. Prices are now much lower than they were when he invested half his cash in July, so his plan to buy in two stages should have worked perfectly. And yet he couldn’t pull the trigger. And what if prices were now 5% to 10% higher than they were in July? Would he have felt better investing that cash when everything was much more expensive?
This is a perfect example of why dollar-cost averaging with a lump sum is fraught with danger. Investors think it will give them an opportunity to take advantage of dips in the market. But when those opportunities present themselves, they can’t bring themselves to buy. Without any plan, they base their decisions on their emotions and their futile guesses about where the markets might be headed. In this case, our investor is likely to remain in cash for a long time, since both rising and falling markets make him nervous, which is an impossible situation. And the longer he sits, the harder it will be to take action.
The lesson here is not that dollar-cost averaging is a bad idea. The point is that if you plan to ease into the market, you need to set a rigid schedule based on the calendar, not on market conditions. You might, for example, invest your cash at three-month intervals over a full year. (Rick Ferri offers some helpful advice about deciding when and how to use dollar-cost averaging in different situations.) Then you need to actually carry out your plan without second-guessing yourself, and that’s harder than it sounds.
This is one place where a disciplined advisor can be of enormous help, especially one with discretionary management. We’ve set up this kind of schedule for several clients with large lump sums they were reluctant to invest all at once. Once the dates are agreed upon, we carry out the trades without any emotional discussion about whether “this feels like the right time.” Because it never feels like the right time.
A disciplined plan is so important because it gives you a reason to invest. Your emotions, on the other hand, will always give you reasons not to.
I was hoping you’d address this topic, amidst the current events. Having a plan is proving to be essential but staying the course is must tougher than i thought. I;ve managed to be discipline the last couple years ( fairly easy with the environment presented) , on weeks like these it’s easy to see how folks could abandon their plan., need displine or a plan to simply not pay close attention, So far i’ve been able to stick to my quartely re-balancing (not always with new money, but still re-balance) but this is the first occasion since writing down my plan that if one of my allocation exceeds a certain % i would re-balance ( ie fixed out by 8%… 30% target… 32.5% then rebalance), looks like some of those threshold are going to happen today.
I’ve been a silent follower for many years, very much appreciate the effort you put in the blog and articles, i’m an advocate of your insights and knowledge sharing, it certainly was key in setting our household on the right financial course. Thanks Mike
Great article Dan!
Quick question: At what point would you consider stocks to be “on sale” when it comes to drops like this?
Is there a rule-of-thumb that you use? ex. When the index drops 15% vs the previous month for example.
I realize the best practice is to invest consistently, but it’s nice to know when there is a buying opportunity if we can muster some extra cash to invest for example.
On another topic, I am using the Larry Swedroe 5/25 rule for asset rebalancing, on times where large swings occurs, would it be the right reaction to rebalance?
@MiCro: Thanks for the comment. Hope you’re able to stay the course!
@R and Kornel: I would suggest that you have a guideline in place for when to rebalance your portfolio, and this guideline should depend on how far each asset class is off its target, not how much the market has moved recently. R, if you are using the 5/25 rule, you already have your answer. Are any of your asset class off target by five percentage points (absolute) or 25% (relative)? If no, then no need to rebalance. With this in mind, it’s quite possible that a pullback could trigger a rebalancing for some investors, but not for others.
Hello, I just received a cash inheritance and would like to set up a Couch Potato portfolio. With approx. $300,000. cash to invest now and another $100,000. in 2016. Considering the recent plunging market can you make suggestions for a sample portfolio of ETF’s. I am semi-retired at 57 years of age without any company pension plan. I would like to generate around $20,000 in interest and dividends to supplement my part time income. I have assets worth $2,000,000. (home & properties)
@Cynthia: Thanks for the comment. It would be inappropriate to make a recommendation without first doing a proper financial plan and understanding your whole situation. This is a good example of when it it can be useful to get professional help: too many people in your situation have just sat on that cash for months or even years because they don’t know where to begin.
This morning XAW was up nearly 7% while VXC was down nearly that much. What is the explanation for this? I decided to go with XAW for my own portfolio but I find myself wondering if I should own both given how they act differently, and maybe to reduce the problems from a fund being shut down for whatever reason. Do you have any thoughts on this?
Your article is very timely for me as I’m working my way into the market after inheriting some money. I managed to stomach buying on Friday but not this morning :-( My dad, from who I inherited the money, made his by buying and holding rural land. I’ve been thinking about diversifying by getting a piece of rural land myself. I know this off topic from your post, but in light of this buying opportunity in the market I’m at a deciding point. Do you have any thoughts in the context of couch potato investing or articles you could link me to that might help?
@Sam: The difference between the quoted price of VXC and XAW had to be an error. There’s no way XAW was up 7% at any point today. What sort of specific information are you looking for? I can try to add a couple of blog links.
More sage advice from Dan ?.
I had been sitting in cash for 2 months waiting for a drop/correction. When the Greek crisis was in full swing I went into a Vanguard and BMO Index ETF coach potato portfolio – based on this blog and the Moneysense recommended ETF’s. I was up $21K after 3 weeks but as of today I am down $11K for a $33K reversal of fortune!
It’s all OK though as I am not deviating from my plan.
Glad to hear that it must have been an error, would be very confusing otherwise. So you don’t see any reason why someone would want both VXC and XAW?
I’ve heard that land goes up around 5% a year, less than equities, but perhaps it could add some diversity to the couch potato portfolio? Or is a single piece of land just too much risk, much like a single stock is?
@Sam: There is definitely no reason to own both VXC and XAW. They are very similar funds that are likely to perform very similarly over any meaningful period.
I’m really not the right person to ask about real estate investments. In general, though, I would agree with you that with real estate you are concentrating your investment on a single asset, whereas with equities it is much easier to diversify. A portfolio of equities is also much more liquid.
I thought I had this all figured out but apparently I don’t. With all this turmoil, why is XGB (Canadian Gov. Bond Index ETF) down -0.4%? Shouldn’t it be screaming through the roof?
@AR: It’s reasonable to expect government bonds and equities to have some negative correlation over time, but it’s not a sure thing, and it’s certainly not something you should expect on a day-to-day basis.
A sage and (always) timely article Dan, thank you for that!
I have a small lump sum built up from a recent windfall, and was deliberating trying to play/time the market a bit, given the recent events. After your reminder to stay the course, I think I’ll just stick to the plan and re-invest it ASAP now, as I usually do.
Thank you again!
Normally there are a few dozen trading halts a day. But Monday wasn’t a normal day with 1,200 halts. “That’s huge. I’ve never seen that many halts,” said Dennis Dick, a market structure consultant at Bright Trading. Dick said he believes the stock market may have suffered even worse losses if it weren’t for the trading pauses. “The circuit breakers are designed to prevent a full-on flash crash. Those circuit breakers kind of saved the day,” he said.
Great points Dan!
Investing with your emotions is NEVER a good idea.
But being disciplined is something that many have a problem doing. Look at how many people are not disciplined enough to eat healthy and exercise on a regular basis – hence the reason why they hire a trainer to keep them disciplined.
For the same reason – this is why it’s good to have an advisor that you work with to setup a schedule to invest regularly based on the calendar, and not based on emotions or what the market is doing.
Question: One thing I’ve always wondered…over the long term (say 10 yrs or more) which strategy will come out ahead and give you a better return at the end:
Dollar Cost Averaging every month or Investing the same amount in a lump sum at the beginning of the year?
@Ryan: There are never any guarantees, but there have been many studies on DCA and almost all of them find that investing a lump sum usually results in higher returns over the long run. But DCA does smooth out the variance in outcomes, so it’s not at all an unreasonable strategy for a large lump sum or a nervous investor.
In practical terms, though, this is a moot point. Most people don’t get paid their full year’s salary in January, so they have no opportunity to make their full year’s investment at the beginning of the year. Some people will save monthly amounts in cash and invest it all at the end of the year, but this is not likely to be a good long-term strategy, as there will be an opportunity cost for sitting in cash all those months. Short answer: invest when you have the cash available.
HI Dan, yesterday I did pull the trigger and made some investments of my planned holdings as determined by the annual re-balancing process I started last month.
I had some cash sitting and needed the time to make the trades, so when I woke to the news the markets were plunging I ran to the laptop, opened the portfolio spreadsheet and entered the trades I needed to complete what I needed to do for this year’s rebalance.
Work schedules and summer holidays have definitely interfered with my getting the rebalancing finished, but I had already made the appropriate sales to start, so the cash was ready to go. I had to miss breakfast to get all the trades entered before I left for work, but it was definitely worth it!
Now I will let everything sit as is until next year when it is time to do the re-balancing exercise. Love my couch potato portfolios!
Dan, it may be worth pointing out that if one gets a lump sum and is nearing retirement where one will soon be drawing income from their investment, then lump sum investing is NOT the best strategy. The best approach that I’ve read about in literature states that you should start with a small equity allocation of only 20% or so and slowly increase it. Details in reference below:
Dan, could you give references to the studies you are referring to that state (lump sum investing) LSI is better than DCA? Are you referring to the Vanguard research paper title “Dollar-cost averaging
just means taking risk later”, if so, that paper assumes you are investing for 10 years and not drawing from the investment, so it’s results are not valid regarding people nearing retirement.
As, I am sure you are aware, once you are drawing from an investment, the sequence of returns matters a lot and that’s why LSI is NOT the best approach should you receive a windfall.
Thanks very much for this article Dan! I’ve been a Couch Potato Investor for a few years now and I have a couple of questions:
I have a plan to purchase ETF’s in my Asset Allocation once my portfolio drops 20%. I am planning to use 50% of my available margin to make those purchases (so that I won’t run into a margin call should the ETF’s plunge further). Are you against using margin? Or is it ok to have a plan based on a percent drop and not a certain time of year?
Also, I’m looking at buying an S&P 500 ETF and am wondering what the difference would be between VOO and VFV? VFV is on the TSX and owns 100% VOO. Would I just choose one based on the currency I would like to use or would the returns of VFV vs VOO erode over time?
I know these are kind of complicated questions, but any light you could shed would be greatly appreciated!
@AJ: Thanks for the comment. In general I don’t recommend using margin accounts or borrowing to invest because of the costs and risks. Nor do I think it’s a good idea to try to choose an entry point. Consider, for example, an investor in 2009 or 2010 who was waiting for a 20% drop before investing. He would still be waiting, and he would have missed one of the greatest bull markets of all time.
As for for VFV vs. VOO, the main difference is simply that VFV trades in Canadian dollars and VOO trades in US dollars. Their market exposure and current exposure is exactly the same. Unless you have US cash to invest, it usually makes sense to stick with Canadian-listed ETFs. These may help:
Thanks for the timely post. I own TD e-funds and have reached a rebalancing threshold. Since the e-funds are mutual funds I won’t know what price I get for either buying or selling units. Given the current high market volatility would you recommend waiting to rebalance, or perhaps waiting until late in the trading day before entering the rebalancing orders? I believe that for TD the order must be entered by 3:00 pm to get the day’s closing price. I could wait for a day with low volatility and make the assumption that nothing would change late in the day.
How reasonable it would be to convert CAD into USD through NG now when our dollar at 11 years low with an aim to purchase some US vanguard ETFs .
Cost of convention not an issue as will cost around 5 + USD , thank you questrade and DLR.U . Planning in the future couple times per year make contributions.
What is the potential for Canadian dollar to rebound in foreseeable future ?
Any thoughts ?
@Tennis Lover, how and when you rebalance is less critical than you might expect. Google for a paper: Jaconetti, Kinniry, and Zilbering (2010). “Best practices for portfolio rebalancing”.
They show that a simple annual or semi-annual rebalance all that’s needed. No need to time the market.
@Tennis Lover: Rebalancing doesn’t need to be precise, so if you place your mutual fund order in the morning and the markets move during the day, it’s not significant. If it makes you more comfortable, you could place the the order late during a day that saw little volatility, but I wouldn’t be concerned about it.
@Brian G: if someone is nearing retirement, hopefully they would be in an asset allocation that protects them against anything that happens in the market. Investing a large amount into the same allocation would then be safe.
If they were dangerously underprepared and taking on way too much risk in hopes of catching up, then investing a lump sum into a more appropriate allocation might be a good time to correct that. Note that “investing a lump sum” could be putting a few hundred thousand into GICs if that’s the right thing for them.
I really like your advice here at CCP. I have been following you for 3 to 4 years and currently
have a discount brokerage account and I am invested in 5 low cost ETF’s. I have two
sisters in the U.S. and would like to help them move their investments to low cost ETF’s,
possibly with a financial planner. Therefore, I would like to know of a website similar to
CCP that covers U.S. investment and tax matters. I also have a subscription to MoneySense.
@Ross: Thanks for the comment. There are a lot of US resources online: I guess it would depend on the specific type of information you are looking for. For a US investor looking at building an index portfolio with the help of a planner, I would suggest starting with Vanguard:
Hi Dan, setting aside your reservations about leverage investing (which are duly noted), I have a question about DCA and implementation of the smith manoeuvre. My mortgage is approximately 20% of the value of our house (currently valued at 1.1 million) and last year I started implementing a form of the smith manoeuvre, essentially drawing down $4k from our HELOC each month and immediately purchasing low cost ETFs (either CDN or US broad market funds) which I hold in a non registered account. Although I have not decided on a cap for this leveraged investing, I think it is going to be somewhere in the region of $100-150k (anything above that probably too risky for me). Current balance of HELOC is 60k and I have been wondering if DCA is the best way to go? I plan to hold these ETFs for the long haul and part of the strategy is tax related (my marginal tax rate is 46% and I am 40 so figure I will probably have many more years of earning income at high marginal rate). Based on your article and the research, maybe I should just go ahead and borrow the full amount and invest now. Side benefit of way bigger tax deduction rather than gradual build up. Your thoughts (and other readers) would be greatly appreciated. Thanks.
@Jamie: Setting aside the reservations about leverage I would think that the lump-sum investment is likely to be the better decision than $4K per month for two or three years or more. However, if you have never borrowed to invest before, then the gradual borrowing might make more sense behaviorally. You mention that $100K to $150K might be your limit, but you may find you actually reach your comfort level at much less than that. Then you can stop without having committed too much.
Thanks for the prompt response. Another strategy I was contemplating was keeping the payments monthly but increasing or doubling the payments when the market dropped significantly (I am whispering these words as I know this is tantamount to market timing – a rubicon that we are not meant to cross!). Great blog, keep up the good work.
I am about to take the plunge with a largish (for me) lump sum. I was looking at the model portfolios and like many others was shocked with lack of difference in returns base on aggressive all the way to conservative choices.
i was left with 2 questions. Given the downside, why bother with anything other than conservative? (Are bonds still as viable as ever?)
Also, why does your aggressive model portfolio differ so greatly in bond allocation from Benders? You recommend 10% while he recommends triple that at 30% .
@RW: Your first question is a common one, answered here:
Justin’s portfolios are primarily designed for PWL clients rather than DIY investors, and we don’t usually go more aggressive than 70% fixed income with these clients. I chose to include a wider range in my own models.
The toughest thing for me to do when I have cash is hoarding. I sold VTI worth of $25K about 2 weeks ago and that day I purchased 8 companies allocating about 3k each immediately. It is hard for me to understand how other people can just hoarding cash and not investing. Thanks for your insight as always!
Cash is part of a diversified portfolio no matter what age you are, maybe just 5% when young and for me at my age 5 years in cash for living expenses.
Selling VTI and just going with 8 companies is the worst move anyone on this site posted in recent memory espeically with only 25k.
I think a pullback is a great opportunity to look at ones actual risk tolerance.
For example, when things went really south, I couldn’t help but look at whether or not I could get some extra cash freed up ahead of schedule, to take advantage of it, whereas some people I know got worried and were wondering if they should be selling or rebalancing (with less equities).
In short, I think pullbacks are great questionnaires, which show us how we actually react to troubled waters, rather than going by 100% theory.
Everyone likes to get things cheap but when it comes to the market it’s the opposite. when a store is having a big sale people flock there, but when there’s a big market sale a lot of the same people don’t buy, they get worried and a lot even sell some of what they have.
Many callers to the BNN market call shows lately have been asking about their energy holdings, some down 50% to 75% of what they paid, most ask if they should sell and buy something else, completely the opposite of what they’d do if a store had a 50% sale. Time to buy energy, it’s on sale and I’d bet in 5-10 years those who didn’t buy would be regretting it.
Human behavior is amazing.
@Jake You also have to remember that the market has already priced in the probabilities of energy prices returning to what you would consider more normal values. By declaring that you believe that energy is on sale, you are thereby saying that these shares or companies are mispriced. You may indeed be right, but you must also remember that some very sophisticated investors may well be on the other side of whatever trades you may decide to make.
The idea of couch potato investing is that you never have to pick winners or losers, or figure out if stocks really are “on sale” or not. Just passively own the index…
We have RRSP, TFSA, RESP, and cash accounts with an investment firm. Approximately 80% US and Canadian equities and 20% cash (money market). Thinking about moving everything over to a self managed ETF portfolio. The CP model portfolios appear to all be Canadian ETFs. In our situation would you recommend converting the US funds to Canadian funds (from the sale of US equities in our accounts) or simply purchase US ETFs with said proceeds? If the latter, any recommendations? Thank you very much.
@Dean: As long as you are able to get a reasonable currency conversion rate you are generally better of with Canadian-listed ETFs in TFSAs and RESPs (and non-registered accounts). If you already have USD in and RRSP, then US-listed ETFs may very well be a better bet. This should help:
Awesome advice CP. Much appreciated.
Can it be said that at least once or twice a year even in a bull market, there will be a big pull back giving buying opportunities. It will always happen I think. There could be a specific stock you want but think it is too expensive, this pull back presents the chance. Dollar cost averaging works if all you are buying are ETFs or index products. Regular stocks can’t really dollar cost average down but then again it could but that’s if you buy it a few times but the fees of $10 or less each time will get more than just annoying, it can cost you.
@Peter: It isn’t the case that the broad markets experience a big pullback once or twice a year, and while it may occur with certain individual stocks, I don’t think you can say “it will always happen.” Even if it did, I don’t recommend buying individual stocks anyway.
good article Dan.
But disciplined investors should have a stock picked out and a set target price. If the markets dip and the target price is met, Why can’t we buy it? It may go down, it may go up. But we waited for the target price? That should be enough justification for buying on dips.
Nice article Dan. With the year’s result i find myself in a position to have to rebalance between US and Canadian equity. Since my US holdings are US$ ETF, i wondered if there was any american ETF that tracked the Canadian market, to avoid having to do a reverse Norbert?
@JeanFrancois: HXT is available in a USD version: