Having read the title of this article, it will inform you that my goal is to explain the main benefits of using a dollar-cost averaging investing strategy. However, first, it is important to understand what a dollar-cost averaging strategy entails, and there is a great chance that you as the reader may already be committing to this strategy without even realizing it! To put it briefly, let’s say you are putting 5% of your income into mutual funds in your 401(k), then you would be using a dollar-cost averaging strategy regardless of the specific frequency of those retirement contributions as long as they are consistent (weekly, biweekly, monthly, etc.) This strategy simply involves investing the same amount of money at these set intervals into stock mutual funds and/or other applicable investments, regardless of price-per-share of those mutual funds. Therefore, by investing with a consistent dollar basis, instead of on a per-share basis, you will buy more shares when the mutual fund(s) is “cheaper”. (Think when the market is “down”.) You will buy less shares when the mutual fund(s) is “more expensive.” (Think when the market is “up”.)
Initially, many advisors and investment firms turn their heads to potential clients that don’t have large sums of money to invest. They try to discourage dollar-cost-averaging knowing that it is a beneficial and proven investing strategy for a vast array of people that significantly reduces market timing risk. This can mean less assets up front to take an initial investment management fee or a commission check. (P.S. As a friendly reminder, watch out for commission-based compensation structures.) I say this because we, at Whitaker-Myers, do not operate that way. There are two main things, among many more, that our advisors and company take pride in: working with and providing great advice, service, and strategies to our clients with THEIR best interest in mind and having the heart of a teacher. If you, the reader, are not an existing client and/or don’t know much or anything about our company, I hope the latter point shows through with this information.
What Are the Benefits?
I would like to dive into the benefits of implementing and using this strategy. I have also included a picture, with credit to Franklin Templeton, that shows a hypothetical illustration or case scenario of using this strategy with results in better investment returns then investing the same amount of dollars, on day one, with a lump-sum. However, the argument for dollar-cost averaging is not completely or even mostly mathematical or return-based in nature. In fact, when you think about the history of the stock market and the fact that it has provided substantial returns with ups and downs along the way, you will generally have a better chance of more substantial returns with an initial lump sum vs. spreading out that same lump into twelve monthly contributions in a one-year period.
Although this is not an exact or concrete statistic, we are on par with Dave Ramsey when he says that finances, investing and underlying decisions are about 80% emotional or psychological and about 20% head knowledge. We would also argue that a perfect world or place to be for an investor would be the use of 100% head knowledge, but this is unrealistic with money, and we understand that. While most of us inherently know that buying low and selling high is a general benefit, many end up committing to the opposite. For the majority of people, the immediate thought when they see their investments decline, in the short-term, is to sell because of the uncontrollable fear of “How much more can I lose?”. Also, for the majority of people, the immediate thought when they see their investments appreciate in the short-term is “How much more can I make before selling?”. Dollar-cost-averaging is especially made to be a long-term buying strategy and a behavioral or psychological benefit:
Dollar-cost-averaging lets you take on the position of timing the market by purchasing more shares of said investment when cheap and less shares are more expensive. This is in the most modest and least-risk inducing way.
The majority of people are not in the position to invest in large lump sums in the first place.
It’s beneficial for the overwhelming majority of investors to commit to a simple and disciplined investing habit or plan.
Pinpoint market timing is nearly impossible, even for professional investors. • Regret and negative results WILL occur with poorly timed lump-sum investing.
If committed to the strategy, you are committing to using bear markets, automatically, as a buying opportunity. Those who try to time the market completely have a historically better chance of failing than succeeding.
Overall, this strategy allows those who use it to aim for great returns over a long period of time. This allows them to take on a much lesser risk that essentially equates to a more positive, emotional and psychological result.
THE BENEFITS OF DOLLAR-COST AVERAGING
January 14, 2021
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