Friday Finance: dollar cost averaging DEBOONKED

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This is an extract from The Poor Man’s Guide to Financial Freedom: A Realistic, 10-Step Manual to Building Liberating Wealth on a Small to Medium Budget.

Diversifying Across Time

There is one more risk to consider and it relates to time.  Not just time in the market, which we already discussed, but also the time it takes to get in and out of the market.

Theoretically, you might invest all your money in the stock market or real estate at the top of a bull market, or bubble, and then make a sudden loss all at once when the market crashes.  I.e., you might have invested in early 2008, right at the worst possible time, and made a big loss in the Great Recession without even having enjoyed the long period of growth that led up to it.

For most of my readers, this is not an issue.  Most will invest their money gradually over time – because they don’t have much yet!  You have to earn and save it first.  Making regular investments is actually a great strategy.  Earn your money, budget, save, and invest as you go along, over many years, regardless of what the market is doing – exactly as you were going to do anyway. 

During crashes, if you stick to the plan, you’ll automatically be buying more stocks while they are cheap.  During a peak, you’ll be buying fewer expensive shares.  You can ignore the blaring market news and keep investing, month after month.  Until you are nearing retirement, it is white noise.

Reversal: if you’re lucky enough to have a large amount of money ready to invest for the long term right now, you might as well invest the total amount immediately rather than doing it bit by bit.  As we have seen, the more time in the market, the better – if the market crashes just after you invest, you will have many years to make it up.  The strategy of investing gradually rather than all at once, when you have the option to do the latter, is called ‘dollar cost averaging’, and research suggests there’s not much benefit to it.[i]  Time in the market is more important. 

If you’re moving from growth to defensive investments as you near retirement, or for some other reason, consider making this change gradually over time to lessen the risk that you’ll suddenly move all your money out of the stock market just after a crash.  Selling shares over time spreads the risk out.  Usually, as people near retirement, they spend a decade or two moving towards ever greater proportions of defensive assets.  However, for most readers, this will be a long way off.


[i] https://seekingalpha.com/article/4067554-dollar-cost-averaging-work

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3 comments

  1. Kentucky Gent · August 28

    Ah, yes. If you don’t have money to invest, then the fixed amount from every paycheck is really the only option. But if you have a lump sum, DCA is almost always the inferior option.

    Looking back on my investing career, this is exactly what I did. During most of the year I invested a fixed amount out of every one of my 26 paychecks. But at Christmas time every year my father would give me a large lump sum of cash as a gift. My mother did the same one year too. And I always could barely wait to invest 90% of those big gifts in more shares. It would be 100% invested with 1 or 2 days of the checks clearing. (The other 10% was fun money.) I treated all company bonuses the same way – investing about 90% in shares. Now I’m financially independent, thanks be to God.

    Liked by 2 people

  2. Catxman · August 28

    I assume you could work a regular job for your money and invest in stocks.

    OR if you were at least halfway decent looking you could drain it from some beeyatch and transfer it to yourself. There is always that.

    — Catxman

    http://www.catxman.wordpress.com

    Liked by 1 person

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