Dollar Cost Averaging
There is plenty to learn when it comes to investing your money; what stocks should I buy? Is it better to reinvest my dividends? Should I own bonds? Wait, what is a bond? It can get overwhelming pretty quick. However, before you even get to those big questions, you are faced with what strategy you will use to get your money into the market. Should you put it in all at once or should you put a little in at a time? The latter strategy is known as Dollar Cost Averaging or a DCA plan. The idea here is that you set a certain percentage of the money you want to get into the market, and you invest it at regular intervals. Picture something like putting in 20% of your money in once a month over the next five months. The theory behind this strategy is that if you if you are investing in a volatile market, you can minimize your downside while potentially entering the market at a lower overall price. Sounds great, right? Not so fast…
I know what you are thinking, “dollar cost averaging sounds a lot like what I am doing in my work plan”, and in a sense it is similar. The big difference is that in the work plan you are investing money as it becomes available to you, in the DCA plan you have money that can be in the market, but you are choosing to take small bites of the apple. The key here is that you are making a decision on money that COULD be working for you but isn’t.
The reason why this isn’t always the best strategy is simple…. Time in the market will always be the best strategy for long term investors, and a DCA strategy reduces the time your money is invested. Now, DCA plans could outperform just getting the money into the market all at once, but the conditions need to be just right, and history has shown us this only happens about 10% of the time. The reason that time in the market will win out 90% of the time is because of how unpredictable it is. Let’s look back over history to test this claim…10 of the best trading days in the past three decades came during a recession, and half of those were in a bear market. But wait, aren’t recessions and bear markets bad? I am going to have a “hot take” here – they aren’t. They are healthy functions of the market and the economy, and as investors we need to know that they will happen and that we will need to stay disciplined and ride them out. If we don’t, we miss out on some of the biggest days that market can give us. If you were not invested during the top 10 days of the market over the last 15 years, your returns would be cut in half…. That works out to only missing one good day every 18 months! If you missed the 30 best days over the last 15 years, your return would be negative. Time in the market always wins.
Now, let’s not pretend like there aren’t some short-term risks to getting ALL your money in the market at once. What if you put it in and the market falls off a cliff? All your money would go with it! On the flip side, what if you put your money in and the market goes straight up? I am going to let you in on a little secret – the market is going to go up and down, no matter when you put your money in and since over time the market trends up, it might behoove us to get as much money in as soon as we can.
I think as we move some money into the market, whether that is in small chunks or big lump sums, we need to really understand our own risk tolerances. We need to be prepared to see the values drop and be able to have the intestinal fortitude to trust the process and know that the values will go up over time. With all of this said, there can be a place in your investment strategy for a DCA plan. It can mitigate the downside and can be the right option for the very conservative investor. However, if we are investing for the long term – time in the market has proven to yield the best results.