Dollar cost averaging is when you decide how much money you are going to invest each month and then chunk it into the market each and every month no matter what. If the media is screaming for the end of the world, you buy. If the stock brokers are having parties in celebration of market highs, you buy. You just keep on with your plan to invest X dollars each month. This way you take advantage of both the highs and the lows. That’s the beauty of it.
Think about it this way. Let’s say you have $1,000 in the market and it drops down to $500. Then the next day it bounces back and it’s back up to $1,000. You just rode the wave and didn’t gain or lose anything.
BUT let’s say that because you are dollar cost averaging you happened to buy $50 worth of stock on the day that your portfolio happens to be at $500. The next day when it comes back to $1,000 your portfolio goes to $1,100. You got 100% return on your purchase. Pretty cool right. But if you didn’t have it already set up you would have missed it.
That’s a simple example but dollar cost averaging does work. Here are some charts that I thought were very interesting!
Isn’t that cool! You could have still made money in the stock market even during the depression! In case you can’t read the slides the first one shows putting lump sum of $12,000 in the market in 1929 and leaving it there for 10 years. At the end of the 10 years you would have had $7,200. The second one shows putting $100 per month into the market for those same 10 years. The end result was $19,400. Same amount of money, same exact period of time. The difference was the strategy! Using those ups and downs in the market to your advantage.
Ok, next set…
As you can see here putting in a lump sum of $12,000 into the market and letting it ride from 1937 to 1947 would have left you with the same $12,000. Nothing changed at all. It was a flat market. However, if you were to dollar cost average that same $12,000 at $100 per month for those same 10 years you would be left with $22,407. Interesting!! Dollar cost averaging comes through again!!
Ok, last set!!
This time things are a bit different. Here our lump sum of $12,000 rode the ever upwards trending waves from 1943 to 1953 and grew to $24,720. Our dollar cost averaging didn’t do as well as the lump sum but still grew to $19,645. Still not too shabby.
Considering you will probably see all three of these types of markets during your investing lifetime you can see why dollar cost averaging is so powerful. It can turn a crappy market into a money-maker and it can join in on the good markets. Yes, if you could predict the future you would pull your money out right before a crash and put it back in right before the recovery. But you can’t see the future. No one can, but dollar cost averaging helps the regular folks like you and I weather the financial storms.