DOLLAR COST AVERAGING
Can you benefit from dollar cost averaging?
Technically, dollar cost averaging involves investing equal amounts of money at regular intervals over a long period. Theoretically, dollar cost averaging is a risk management technique. New investors are encouraged to use this technique with mutual funds or ETF’s because, it is easy; it is almost mindless. Theorists suggest that you will sometimes buy high and sometimes buy low with this strategy. Therefore, you average out your cost basis.
Although I am now retired, my many years of investment adviser experience and my personal investing experience has provided evidence that you can benefit from regular, periodic investments. On the other hand, experience with my own money and dollar cost averaging proved to be less stellar than its supporters suggest.
I started paying attention to investing in the late 1970’s and early 1980’s. Just about the same time, I was earning my MBA. It seemed to make so much sense to buy let’s say $100 per month of a mutual fund. At that time, few no load funds were available and the ETF had not yet been invented. Over the next nearly 15 years, I bought higher and higher and higher. I had a little bit of a chance to buy low in 1987 but that was short lived. I only bought low in two of the months.
If you started buying after the 1987 crash, you would have had the same experience I had, buying higher and higher. If you started buying after the dot com crash of the early 2000’s you would be buying a basically flat market until the last couple of years when you would be buying higher and higher.
Folks, it just does not work. Investing is not for the mindless. However, we know that our lives are complicated and filled with activities and we do not have as much time as we would like to pay attention to our investments.
I like a hybridized concept of dollar cost averaging using dividends. Readers of my website/blog and hubs know that I believe in income investing. I think it has a place for retired people but I also think it applies to younger people who are accumulating wealth. It is not just for those using their wealth for income.
When you buy a company that meets the criteria of a dividend machine (there are four criteria that you can read about on my website www.themoneymadam.com) you are buying a company that increases the dividend every year. When you reinvest the quarterly dividend, you buy more and more shares every time. You can decide to add to the number of shares if the stock price goes down in investing environments like those that we have today. Even if we just plug along for 10 years as we did from 2000 to 2010, you will be buying more and more share every quarter. You essentially have employed dollar cost averaging. Then when you are ready to use the wealth you have accumulated for income, you simply stop the dividend reinvesting and turn on the income spigot. Employ this technique with multiple companies and soon you will have a very nice income stream.
The moral of the story (or the hub) is dollar cost averaging as a theoretical technique has virtue. It is not mindless. Most mindless investing has poor results.
Very Truly Yours,