In a previous article, I have talked about one of the common pitfalls of trading which is investors trying to time the market. When I say this, I mean they think they can call the lows and highs of stocks to get in at a good price. THIS IS IMPOSSIBLE. In my time as a broker I talked with many clients who would tell me that they are waiting for the market to come down off its high before they were ready to invest. Often times, I would look at their account and realize they had been sitting in cash since 2008! That’s 8 years of bull markets (continued upward trend in prices) that they missed out on.
This kind of thinking continues constantly. Many investors fear that we are heading into a bear market with Trump now in office as president. The Dow is hitting all times highs almost every day. The end is near! Or is it? Do we really know what is going to unfold in the coming years? We have been hitting all-time highs on the Dow since 2013! We all wish we had a crystal ball to see into the future but unfortunately that’s not how life works and with investing you could be waiting around for another 5-10 years of bull markets before you ever put any money on the line.
Other people blindly follow the heard or a “hot new stock tip”. What typically happens is a stock or the market as a whole will have a big upswing. Prices are rising fast, lots of people are making money, and the media is buzzing about it. The media likes to prey on investors emotions. The typical investor will see this and say “I am missing out!” and then proceed to buy at the peak of this upswing. Then everything starts coming back down (remember the stock market is cyclical just like the economy) and that same investor panics because he has lost so much money and sells out, taking a huge loss. This happens over and over again till that investor is wiped out of cash.
In this article, I’m going to be talking about one investing strategy that can take emotion out of your thought process and set you up for great returns. This investment strategy is called Dollar-Cost Averaging.
Dollar-Cost Averaging is simply making periodic purchase of a stock at a fixed dollar amount. In a fluctuating market, the average cost of the stock purchased is this manner is ALWAYS less than the average market price. Yes, you read that right. If you implement dollar-cost averaging over a period of years it will not matter if we are in a bull market or bear market, your cost-basis will be lower than the average market price during that time.
For example, let’s say that Jim invest in Disney when it is trading at $90dollars a share and plans to invest $500 more dollars to this investment every quarter no matter what Disney is trading at. The next quarter the market has taken a dip and Disney has dropped to $85 a share. Jim buys as many shares as he can with his $500 dollars at this time. The next quarter Disney has seen great sales and its stock is now trading at $92. Jim takes his $500 dollars and invest as many shares as he can get at this price. Jim is successfully saving and growing his portfolio without worrying about his investments.
Key advantages to this strategy:
Takes Emotion Out
You do not want to constantly worry about the value of your investments or speculate on whether or not the market is going to take a dip.
Makes You Stick to a Plan
Investing money at periodic increments keeps you organized with your finances and encourages you to save.
Makes You Robotic
The goal of trading is to make money while you sleep and not worry about your investments. The more automated you can make your investing the better off you will be.
Can Lower Your Cost-Basis
Even if you bought a stock at a higher price you can still lower your cost basis by using this periodic investing system.
***Important Note** By no means am I encouraging you to keep blindly sinking money into a stock that is not performing well over time. You still have to be aware of how the company is functioning and the likelihood of recovery. Do not keep sinking money into a loser!
To summarize this article, when is the best time to invest? Now! Don’t not sit on the sidelines while you could be putting your money to work. Could the market collapse? Yes. Could you see your investment lose value initially? Yes. Could you just as easily trip over a sidewalk? Yes. My point is that anything could happen at any time. Instead of living in fear we should make a plan, mitigate risk, and stick to that plan!
Homework: If you are currently invested in stocks or were planning on investing, make a plan to utilize the power of dollar-cost averaging. If you have stocks that you plan to invest in long term, pick out a dollar figure and time schedule in which you will periodically invest more.