Investor Toolkit: Invest as you earn — a simple strategy for successful retirement investing

Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a new or experienced investor, these weekly updates are designed to give you specific advice on the fundamentals of successful investing. Each Investor Toolkit update gives you a fundamental tip and shows you how you can put it into practice right away.

Today’s tip: “Life-long dollar-cost averaging can increase your long-term retirement investing profits”

Dollar-cost averaging involves investing equal amounts of money over a specific period ($200 a month, say). It’s a little like systematic saving, except that you put your money into stocks (or mutual funds) instead of a bank account.

Advantages of dollar-cost averaging:

• Dollar-cost averaging helps build consistent long-term retirement investing returns: Long-term studies show that the stock market as a whole generally produces total pre-tax annual returns of 8% to 10%, or around 6% after inflation. Over periods of a few years or less, the return is far more variable and always uncertain.

  The surest way around this uncertainty is to start practicing dollar-cost averaging as early as possible, and invest regularly over the course of your working years. Then you can sell gradually in retirement.

• Dollar-cost averaging largely frees your retirement investing from stock market trends: In fact, if you invest a fixed sum at regular intervals throughout your working years, perhaps increasing that sum from time to time as your income rises, you can largely forget about market trends. That’s because you’ll automatically buy more shares when prices are low and fewer when they are high, and your retirement investing will benefit from the long-term rising trend in the market.

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Lets look at an example: Let’s go back a little over 9 years, to January 2, 2001. Say your employer pays you an annual bonus of $1,000. As part of your retirement investing, you create a dollar-cost averaging program that involves investing this money every year in shares of Scotiabank (symbol BNS on Toronto), one of the stocks we cover in our Successful Investor newsletter.

On January 2, 2001, Scotiabank shares closed at $20.58 (all share prices adjusted for a 2-for-1 split on April 1, 2004.)

Over the following years, Scotiabank shares rose as high as $54 (in 2007), fell as low as $24 (in the market downturn of 2009), and rebounded to $48.93 on January 4, 2010, when you would have made your latest purchase.

However, thanks to dollar-cost averaging, you would’ve bought more Scotiabank shares when they were low and fewer when they were high. So, if you bought Scotiabank shares on the first trading day of every year from January 2001 through January 2010, your average cost would have only been $37.66 a share.

Right now, Scotiabank is trading at around $51 a share. That means you would be ahead by $13.34 a share, or 35%.

It’s worth noting that this gain doesn’t include Scotiabank’s dividend payments, which have risen significantly over the past 10 years. In 2001, the bank paid an annual rate of $1.24 a share, for a 2.8% yield. By 2010, that payout had risen to an annual rate of $1.96, for a 3.8% yield.

Next Wednesday, August 4, 2010, Investor Toolkit will show you nine key factors you can use to judge a stock’s investment quality.

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