The strategy we will look at today is dollar-cost averaging, a conservative and safe approach to ensuring your assets are insulated from volatility. While it may reduce maximum possible gains, it also helps reduce overall losses.
Chasing investment performance, panic selling, and constant portfolio reshuffling are great ways to consistently buy high and sell low – the complete opposite of an investor’s goal. Nobody can time the market or predict the headlines, but there are strategies that, when strictly adhered to, will generate consistent gains.
The strategy of dollar-cost averaging is quite simple, really.
The Dollar-cost averaging Process
First, you determine what percentage of your monthly income will go into your brokerage or retirement account. Then, on the same date each month, you plug that money into your investments. Sometimes you will purchase assets when they are at market highs. At other times, you will purchase them when they are at market lows. In the end, it gives a more median average cost of the investment vehicle.
Let’s look at two different scenarios.
fomo jim
Jim doesn’t have the patience for a dollar-cost averaging strategy. He knows he wants to purchase ABC stock but feels the price is too high. So he waits, and he waits, and he waits. Finally, he puts a few thousand dollars into ABC because he has a fear of missing out (FOMO). Jim watches with glee as prices continue to rise. Unfortunately, In just a few weeks, Jim is hit with a stroke of bad luck. ABC has reported lackluster sales, and share prices start to slide. Jim, in a panic, sells while he can before he starts to lose money.
In a couple of weeks, ABC puts out some good news again. Jim, excited about finally making it big, again puts those funds into ABC. And the cycle repeats. Even if he doesn’t lose money each time he buys and sells, the trading fees, combined with the bid/ask spread, will eventually take their toll. Things would probably be different if Jim utilized a dollar-cost averaging strategy.
disciplined stacey
Stacey, on the other hand, uses a dollar-cost averaging strategy. She diligently puts $500 into ABC on the first of each month. She doesn’t wait for prices to drop before purchasing. Stacey actually buys when the price is medium-high, and then when they are high, and then when they drop. Most importantly, she never sells. She spends less overall on the stock than her compatriot Jim has. Stacey is disciplined and determined – and she doesn’t let her emotions get the best of her. Astonishingly enough, she never even looks at her account value or reads the news and she still does better than Jim!
Now, the cardinal sin both Stacey and Jim are committing is stock picking, especially if the only thing they are putting into is that single stock. Dollar-cost averaging with single stocks cannot replace a diversified portfolio consisting of mutual funds, ETFs, and bonds, whether they be actively or passively managed. Choosing such a scenario serves to emphasize a common investing mistake made by DIY investors and day traders.
dollar-cost averaging combined with portfolio rebalancing
Another benefit of dollar-cost averaging is the ability to rebalance your portfolio without having to sell assets. If you notice that your stock proportion is low compared to your bond proportion in your portfolio, instead of selling bonds and purchasing stocks to make up for the discrepancy, you can simply buy more stocks. This will save you money on expensive fees.
In conclusion
Dollar-cost averaging will ultimately save you time, reduce your stress levels, and make you more money, over the long term. You may be losing large potential gains by not lump-sum investing, but that is akin to winning the lottery since you never know if a stock or fund will go up or down in value. When it comes to dollar-cost averaging, it’s about staying the course and building a strong position, not gambling on specific directions.
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