While we’re on an investing kick this week I thought I should bring up one of the more fundamental ideas of investing, and that is dollar cost averaging. New investers tend to look at performance charts and dream big about buying low and selling high. But it’s impossible to “time the market”. A better strategy is to invest consistently over a long period of time.
Investing the same amount every month, over time, means you will sometimes buy shares when the share price is up, and other times buy shares when the share price is down. But your average cost is what’s important.
This is dollar cost averaging.
Here’s an example of how it works: If I invest in a mutual fund that currently costs $8 per share, and I invest $100 this month, that’s about 12.5 shares. If I invest the same $100 next month, when the share price has gone up to $10, that’s 10 shares. So now I’ve spent a total of $200 on 22.5 shares, which means my average cost per share is $8.89. So at the current $10 price per share, my two-month portfolio of 22.5 shares (which only cost me $200) would be worth $225.
Use this method over 20 or 30 years, and you’ll save yourself huge headaches over trying to time the market, putting all your money into a stock just before it falls, and in the end, coming up short.
Remember that your investing should be for the long-term.
In the short-term, prices might go down. You don’t want to cash out your shares when prices are down. That’s how you lose money. Any money you will need within the next two or three years, should be in CDs or savings accounts, or other guaranteed, but low interest-earning vehicles.
Over time, however, prices have always gone up. Over the last 25 years, the stock market has had an average annual return of +11%. Even over the last nine months, recovering from the largest hit the market’s ever taken, we’ve already recovered more than 50% of the losses. I have no doubt that over the next few years we will see a full recovery. And the only people who will actually lose anything, are those who cash out early, before we recover fully.
There is no best time to begin investing and saving for your future. The best time is right now, or as soon as you’re out of debt. And the best way is slow and steady and consistent. It’s boring, but it works.
