Volatile markets are the perfect time for investors to dollar-cost average into their investment strategy.
In the last two weeks we’ve seen the stock market have violent moves in both directions. We’ve had two BIG up days that have been followed by more BIG down days.
On the up days, it feels like the coast is clear, the dust has settled, and the market will continue to go higher from here.
On the down days, it feels like we’ll never make money in the stock market again, and you may question why you invested in the first place.
It’s this back and forth swinging of emotions that can drive investors absolutely mad.
We all know that buying low and selling high is the primary idea behind investing. But it’s nearly impossible to do on a consistent basis. Especially in choppy, volatile markets like we’re in now.
So what’s the solution?
There are no silver bullets when it comes to investing. Nothing works all of the time. But if you have a long enough time horizon, dollar-cost averaging into a diversified portfolio will get the job done.
What is dollar-cost averaging?
The idea when you dollar-cost average into your investments, instead of making lump sum, all-in/all-out calls, you decide to invest a set amount of dollars at a regular interval of time no matter what.
Investing in a 401(k), 457 or other type of retirement account is a great example of dollar-cost averaging. You invest a set percentage of your paycheck every two weeks and it goes into your selected investments.
It doesn’t matter if the market is up, down or sideways. You are steadily investing dollars, buying shares of investments sometimes at a lower cost and sometimes at a higher cost. But it’s automated and relatively low-stress.
**Side bar: if you are dollar-cost averaging into a retirement plan and have a 10+ year time horizon, the stock market going down is EXACTLY WHAT YOU WANT. You are buying shares at lower prices, which will be of benefit to you in the long run.
The Benefits of Choosing to Dollar-Cost Average
There are two major psychological benefits to dollar-cost averaging into investments.
The first is that you won’t be left waiting for the market to go down before you invest. This usually occurs when markets are going up. This is the not-as-much-talked-about part of the “jumping in/out of the market” decision. Even if you nail the decision to get out, you have to make another decision when to get back in.
The market is moving faster than ever before. And the research shows that the best and worst days of the market happen in very close proximity to each other. The decision to dollar-cost average eliminates the need to “wait for the dust to settle”. Because in our experience, the dust never settles. Waiting for calm in the markets is likely to cost you.
The second benefit of deciding to dollar-cost average is it eliminates the fear that you will invest a lump sum and watch it loose 10, 20, 30% right off the bat. This usually occurs when markets are going down. Although every market sell-off looks like a buying opportunity in hindsight, actually putting large sums of money to work when markets are down is tough for even the best investors.
Dollar-cost averaging, or investing in systematic chunks, takes that risk somewhat off the table. The research shows that investing in a lump sum is often the better option. But is the mental stress it could potentially cause worth it?
Each investor is different and will have their own set of preferences. That’s why we present the data to our clients when making these decisions. Especially if it’s surrounding a big life change, like retirement.
The past two days in the stock market (+3% yesterday, -4% today) serve as a reminder that nothing is a certainty when it comes to investing. Successful investing is all about consistency and sustainability.
Dollar-cost averaging is one way to take the guess work out of investing. It is the simplest way to get much needed exposure to the markets. And doing it over the long term puts the odds in your favor.
Regardless of the amount of money you have, the worst thing you can do is not invest at all.