We’ve all been in the situation when getting ready to check out at the grocery store and there are two lines to choose from. You pick the slightly shorter one but suddenly the line next to you becomes the shortest. You shift over to that lane, thinking you’re going to check out faster, only to have the person in front of you whip out a wad of individually cut out coupons. You look back to your original line and it’s still moving at a constant rate, but others have now taken your spot. In hindsight, it would have been better to have just stayed in the original lane.
This way of thinking is useful for wealth management and investing in the stock market. Often, a steady hand can be more effective than attempting a “clever” market-timing strategy. The Dollar-Cost Average is an investment management method that helps to ensure that you invest regularly to take advantage of the natural fluctuations of the stock market. This is a simple but effective strategy that tracks the market and avoids high-risk decisions such as trying to anticipate the next big move or basing your investing strategy on emotional decisions.
How Does Dollar-Cost Averaging Work?
Instead of investing one lump sum, the Dollar-Cost Average strategy invests a consistent amount on a regular schedule regardless of the way prices are trending. This strategy helps soften the potential effects of market fluctuations by buying stocks when prices drop and when prices rise. A risk is that the market benchmark, stock, or fund you select does not grow over time. During a period of decline, even a Dollar-Cost Averaging strategy could lose value. However, the longer you use this investment management strategy, the more you reduce your average cost per share.
Example of Dollar-Cost Averaging
Let’s see what Dollar-Cost Averaging looks like in action. For this example, say you’ve decided to invest $500 in the same stock or mutual fund on the 15th of every month. Because the price is always changing, you end up purchasing different numbers of shares from month to month. A year of investing might look like this:
|Cost per share||Amount invested||Shares purchased|
In this scenario, you end up holding 118 shares of stock on December 15, for which you paid an average of $51.83 per share, far lower than the $80 stock price experienced in December. Because you kept the dollar amount the same every month, you naturally purchased more shares when the price per share was lower, and fewer shares as it rose, winding up with a better average price than the price in December.
It’s true that you would have paid even less if you had put all $6,000 in on March 15, when the price was lowest. But it would have been very unlikely that you could predict the stock’s lowest point. By using dollar-cost averaging, you gave yourself an advantage, paying a lower average stock price, without attempting to time the market. Plus, you invested $500 per month, instead of a $6,000 lump sum, so it can be easier on your monthly budget to Dollar-Cost Average.
Disciplined Investment Management
Regardless of how much research you do, trying to predict short-term market movements is difficult. Even the most experienced wealth management advisor struggles with timing the market, no matter what they’ll tell you. Depending on your wealth management strategy, an investment advisor like Morgan Rosel may use a form of Dollar-Cost Averaging to ensure your money is tracking key benchmarks.
Many financial investment advisor will tell you, having a set spend amount for each month can reduce both your average per-share cost and potentially reduce volatility in your portfolio. The Dollar-Cost Average strategy naturally buys the dip, meaning you’ll buy more after the price drops, setting you up to potentially take advantage of future increases in the market.
The top rule of compounding is not to interrupt it unnecessarily. Investors should pick a strategy that has the best odds of meeting their goals and stick to it. If you can meet your goals without taking the unnecessary risk that comes from trying to beat the market, then why bother trying to beat the market? Many of the most successful wealth management advisors rely on a high savings rate, patience, and optimism that the global economy will create value over the next several decades.
It’s hard to avoid the human instinct to want to invest only when you think you’re getting the best price and sell when the outlook is negative. However, it’s important to remember that what you think is a good investment at the time might evolve into a bad investment in the months to come depending on how the market performs. That’s why some of the most successful investors develop a strategy and just plain stick to it.
Hire a Wealth Management Advisor
If the ups and downs of the stock market make you nervous, consider hiring an investment advisor and wealth manager like Morgan Rosel. We take the stress out of wealth management by providing proactive guidance and fiduciary investment advice encompassing your high-net-worth needs. Please contact an advisor to learn how we can help.
This commentary reflects the personal opinions, viewpoints and analyses of the MorganRosel Wealth Management, LLC (“MRWM”) employees and guests providing such comments, and should not be regarded as a description of advisory services provided by MRWM or performance returns of any MRWM Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. MRWM manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results. MRWM may recommend the services of a third-party attorney, accountant, tax professional, insurance agent, or other specialist to clients. MRWM is not compensated for these referrals.