Dusting Off Dollar-Cost Averaging
You are currently witnessing, and hopefully participating in, the longest bull market in history. In fact, since February 2009 (through 6/24/19), the S&P 500 stock index is up over 250%.
The term bull market generally refers to a 20% gain from a low point with sustained growth over time. The moniker “bull market” can apply to other things, like the housing market or commodities, but in this instance, it refers to the S&P 500 stock index.
While the bull market we are experiencing has surpassed unprecedented levels, normally bull markets only last 4.5 years on average. We know past performance is no indicator of future success, however at some point the bull market will end. When this happens, prices will drop and new opportunities will be available to investors.
Purchasing the same item, such as mutual fund, for less money (versus previous purchases) may seem logical to most investors yet the historical behavior during market declines has been the exact opposite. As recently as December 2018, actively managed funds had record outflows of $143 billion largely triggered by a little dip in the market. When investors flee the market, they are not only forgoing a potential buying opportunity, but doubling down on that mistake by selling their existing investments at a lower price and moving to cash.
A record-setting bull run and less expensive investments aren’t as simple as they seem. If “buy low, sell high” was a strategy that investors successfully executed on a consistent basis, we would all wait until the stock market hit rock bottom, invest all of our money, sell at the peak and start over again. The problem is market timing doesn’t work. You simply can’t pick the highs and lows on a consistent basis.
Dollar-cost averaging is where you invest the same dollar amount on a consistent basis regardless of price. One of the most common examples of dollar cost averaging is your 401(k) plan at work. Your contribution is automatically deducted from your paycheck each pay period, hopefully your company adds a match, and then that money is invested on your behalf, regardless of price, according to your previously decided asset allocation. One of the benefits of dollar-cost averaging is it removes the temptation of market timing. In fact, you are not timing at all because you buy across virtually all points of the price spectrum…high, low, and in-between.
Dollar-cost-averaging also helps you participate in low price environments helping to offset the prices you may have paid at the peak of a bull market. When you average all the price points together, you find a happy medium—not the cheapest price but not the most expensive either.
The key to successful dollar-cost averaging is to set up an automatic investment plan to:
- investment systematically,
- at regular intervals,
- without regard for market conditions or price,
- for an extended time.
Market downturns are inevitable. Make sure you are taking advantage of lower price environments and mitigating higher price environments by implementing a dollar-cost averaging strategy today.
Would you like to set up a dollar-cost averaging plan for yourself?