Fire Drill: Investing with Dollar-Cost Averaging
Do you ask these questions, just like some of our clients?
▶︎ “Should I wait to get into the market?”
▶︎ “Should I wait for the market to go down before I invest?
▶︎ “Do you think I should invest my money on Monday or right now?”
Financial advisors used to rely on crystal balls to decide when to invest — but those stopped working in 2008! Instead of acting like you know when the best time to invest is, create a plan to invest.
Then, here’s the trick: Follow and stick to the plan.
Dollar-cost averaging is a technique to take the emotions out of investing by following a plan:
Dollar-cost averaging (DCA) is an investment strategy in which an investor divides up the total amount to be invested across periodic purchases of a target asset in an effort to reduce the impact of volatility on the overall purchase. The purchases occur regardless of the asset’s price and at regular intervals; in effect, this strategy removes much of the detailed work of attempting to time the market in order to make purchases of equities at the best prices.
It goes like this: Instead of putting so much pressure on when to invest, put a set dollar amount into your investment account on a set schedule. For example, contribute $250 to your IRA on the first of each month. By following this strategy, you’ll find that you’ll have contributed $3,000 through periodic contributions by the end of the year.
You can also look at the psychological benefits. Through DCA, you hedge against “buyer’s remorse.” Imagine this scenario: You invest a large amount of money at a stock market high right before a significant drop in the market the next day. This scenario can cause you to psychologically dwell on what you should have done differently. By following the DCA strategy instead, your staggered contributions allow you to know you’ll make some investments near market highs, some near market lows, and others somewhere in the middle.
Now, how do you take advantage of DCA? Leverage ways to make DCA contributions automatic so you can be lazy with your savings. This strategy is nice because you can gain the confidence that you’re being responsible without doing much. You do this by linking your checking account to your IRA and then schedule recurring contributions throughout the year. You can decide when you want your transfers to happen in these examples — whichever strategy makes you feel comfortable:
▶︎ On the first of the month
▶︎ On a specific numbered day of the month (e.g., the 20th of every month)
▶︎ The day after your paychecks hit your checking account
▶︎ Multiple times a month
With some investment providers like Betterment, whenever you contribute to your account, the full dollar amount of your transfer is invested throughout your diversified portfolio without any transaction costs. This strategy allows you to know you’re consistently investing versus just building cash reserves. Isn’t technology lovely?
▶︎ Learn how you can get a 40% discount off Betterment’s fees with our services.
This automatic investing strategy helps because many people feel they’ll have the wits and courage to invest their cash when the markets go down. However, when the markets go down, fear begins to spread, which freezes a lot of people — especially when it comes to financial decisions. By sticking to your DCA plan and automatically investing versus just stashing cash, you can combat investment paralysis.
As Thomas Rowe Price, Jr said about trying to time the markets:
“History and experience have proven that correctly predicting the timing and extent of stock market trends is impossible, because world developments and the psychological reactions of people are unpredictable.”
If you’re already committing to investing regularly, then here’s a friendly nudge to increase the dollar amount of your contributions. If you’re not regularly investing, there’s no time like the present to save for your future. You can speak with your financial professional to get an idea about where to start.