The common mantra in investing is: Buy low sell high! But how do we know when is low? How do we know when is high? The problem with a lump sum investing is you must be right both when you buy (buy low) and you must be right when you sell (sell high).
In this blog, we will discuss the buying low side of the popular mantra. There is only one day in the year when the market or investment is at its lowest point in the year. If we cannot predict (we can’t) when that time will be how do we ensure that we are buying at a good entry point? The answer is… we don’t, but we can do a few things to reduce the risk of bad timing. We want to buy at multiple entry dates to average out our purchase points, take emotion out of investing, and create a streamlined process to make sure we are investing the amount we need to. This is called “Dollar Cost Averaging.”
Dollar Cost Averaging is the spreading out of our purchases of investments equally throughout the year. Let’s take the example of maxing out our 401K. The current limit for a 401K contribution is $18,500 (under 50 years old) and $24,500 (50+). If we do payroll every other week, we will run 26 payrolls by year end. So, starting the first payroll and going forward we will contribute $711.53(18500/26). We will be investing that amount into our 401K. Since we are not changing the dollar amount or trying to time when we make the contribution, we will just be buying $711.53 worth of shares at the current price. If the investment is $10 per share we will buy 71.15 shares, $12 -> 59.29 shares, $8 -> 88.94 shares, $14 -> 50.82 Shares. Through this buying, we end up buying 270.21 shares of the investment with an average price of $11. So, through this short time period IF we picked when to make our investment we could have done better 50% of the time and we could have done worse 50% of the time, but by setting it and forgetting it, we reduce that risk and get a better average buy-in price, which increases our portfolio value.
Since inception, the stock market has gone up and it has gone down and given enough time always trends upwards. By taking our emotions out of the equation and setting up systematic contributions, we are rewarded from this volatility. When markets trend upwards we gain value in our portfolio. When markets drop we are buying more shares with the same amount of money, which compounds our gain in value when the markets rebound. Instead of picking when to invest based off emotion, it is important to invest multiple times throughout the year.
If you have any questions about Dollar Cost Averaging give us a call, 913-681-9155 or email Taylor@engageadvisors.com.
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