Dollar-Cost Averaging. A Great Long-Term Strategy.
Investing in the stock market can be stressful. Some investors constantly worry about a market "crash." When the market does fall, some have buyers remorse and wish they would have waited to buy at a lower price.
And yet, for those that don't have money invested, some constantly feel like they missed out on an opportunity. They often wait for the market to go back down before buying, only to see it continue to go up.
No one really knows what the market or an individual stock will do in the short-term. The factors that can influence it are many, and unforeseen things happen all the time. However, history shows over the long-term the stock market and a quality company's stock price steadily rise.
Dollar-cost averaging, what is it?
Instead of trying to time the market perfectly (which is nearly impossible) or worrying about what the price is now, try another strategy: Dollar-cost averaging (DCA). This is a simple strategy where a fixed amount of money is invested in a particular investment (like an ETF or a stock) at regular intervals over a long period of time.
For those with a retirement plan through an employer, like a 401k or a Simple IRA, that is already happening. Each month the contributions go into the employee's retirement account and buy into the existing funds they already own regardless of the price.
If someone is investing on their own, the idea is simple. Set an exact dollar amount to contribute at an exact time, like monthly or quarterly. Regardless of the price of the particular investment at that time, buy more shares with the new money contributed to the account. In doing so, the amount of shares they acquire will vary on the price per share, but the amount of investment will be the same. If the price is down, they will get more shares. If the price is up they will get fewer shares.
How it works
For example, let's say someone wants to invest $5,000 that they want to start investing with. They could invest all $5,000 at once into an investment (like an ETF) or they could split it into five intervals of $1,000 for the next five months.
So for each month, on the 15th of the month, they buy shares of a growth ETF with $1,000. They start in July with a price per share of $100 and acquire 10 shares. In August, the price went down to $80 per share and they acquired 12.5 shares. In September, the price was $75 per share and they acquired 13.3 shares. In October the price goes up to $90 a share and they acquire 11.1 shares. Then finally in November the price went to $110 per share and they acquired 9 shares.
By the end of the five months, they have now purchased 55.9 shares and spent the whole $5,000. This gives an average cost per share of $89.45 ($5,000/55.9) and an ending balance of $6,149 (55.9 x $110). Had they purchased the whole $5,000 at once in July they would have had a cost per share of $100 and owned 50 shares, with an ending balance of $5,500.
This is just an example, and of course the price per share could have gone up each month as well, creating an outcome worse than just buying it all at once. However, the strategy works over a long period of time. It evens out the highs and lows, lowers investment risk, and creates a less emotional experience.
Keeping a set schedule is key. Instead of worrying about the current price, stay focused on the long-term goal of putting your money to work on a consistent basis. Save, invest, repeat. In the years to come it can be quite astonishing to see how well it worked.
To get started, consider these points
Decide how much to invest. Set a reasonable amount and stick to it.
Decide how often to invest. Weekly, monthly, or even quarterly are good choices. The more often the better. Many find monthly easiest, like paying a monthly bill.
Decide a time frame to invest for. Five, 10, 20, even 50 years. The longer the better. Investing is long-term. Don't confuse it with a short-term venture. Think in terms of years and decades, not days, weeks, and months.
Stick with the plan. Don't get caught up with the price for the day or week or even the month.
There is no one perfect strategy to investing. However, the most important factor is to do what works best for you, and get started sooner than later. If you are interested in getting started or need help formulating a strategy, feel free to contact us.
Content in this material is for general information only and is not intended to provide specific advice or recommendations for any individual. The economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Investing involves risk and you may lose your principal.