Costly dollar averaging
Posted On March 29, 2020
Or to be more proper, “dollar cost averaging” is simply a way for investors to feel safer about the buying price of their equities. To get the overview here, in most stock market investments, we have 2 main events, buying and selling. There’s some stuff in the middle there that really clever people can get into about capital gains and losses but most of my readers here aren’t quite at the level of investing that requires those types of complex strategies.
Dollar cost averaging is a way for investors to ensure that they aren’t buying at the top of the market when it is about to fall. They do this by not investing all at once. They will take their money and buy stocks incrementally throughout a period of time.
Let’s put this into a scenario. Let’s say you are new to investing and you have $1000 dollars, but like most, $1000 dollars is a lot to you and you don’t want to see it plummet if the market decides to take a nose dive. You can use dollar cost averaging to put in $100 dollars per whatever unit of time you want to use (days, weeks, months) so that if the market drops as soon as you start putting money in, you still have $800 or $900 that you can now use to buy stocks at the new, lower price.
This can be a good strategy when we are going through a recession or if we are in the midst of a bear market. This is because the market is actively declining, and while it is important to buy, it can also help people’s stress levels by not buying all at once when we are still going down.
Why I don’t generally like dollar cost averaging.
I generally don’t like dollar cost averaging because it allows us to get emotional about our investments. If we start using this strategy it can be tempting for investors to wait for the bottom of the market to buy, but the whole point is that you don’t know when the market is bottomed out until it’s already on it’s way up. As studies have shown this is actually more likely to end up in a loss of total gains as it keeps your money out of the market for longer.
I don’t dollar cost average nor do I really plan to. I see my biweekly 401(k) contribution as a dollar cost average and that’s good enough for me. My tax returns hit my Robinhood account all at once, and so will mine and my wife’s stimulus check if and when we get it.
Dollar cost averaging is a viable strategy as it can make people more comfortable with putting larger amounts in to investment vehicles. Although it isn’t mathematically as lucrative, there is value in it if it helps you sleep better. My one rule to dollar cost averaging is that you pick your time frame, and your specific date for each deposit and stick to it. Don’t wait past those deposit windows or else you are officially a market timer, and I don’t play that game.
I am currently perfecting the spreadsheet that I personally use to estimate my retirement age, retirement income, as well as give myself an overview of my budget. I hope to get it to a point where I can share it with you all so that you can benefit from it as well.