Most mutual fund investors are all about choosing a particular fund or funds. But that's only half of the real story when investing in mutual funds. The way money is deployed into those funds is at least as important as the particular fund the money goes into.
The quick basics on dollar cost averaging (DCA) are simple: The same amount of money put into a fund at the same frequency, commonly once a month. No deviation from this rule.
DCA makes price volatility an advantage. Share value drops, your monthly contribution buys more shares. Share value increases, your dollars buy less.
Beautifully simple. The recent economic debacle from '08 gives a good example: The Dow dropped to around 6500 from 12800. If you'd been DCA at that time your monthly contribution would have bought shares at a 50% DISCOUNT. As you can see with basic math, this pulls your cost basis down dramatically.
Conversely, if you'd panicked during this time and reallocated less, or stopped altogether, you'd have missed a super BUYING OPPORTUNITY. If you'd sporadically invested when your emotions told you to, you'd likely have missed some opportunity too.
The '08 crash is an extreme example, but it does illustrate the point. The numbers may change, but the system doesn't.
The ONLY way to make money in stocks is for share price to increase from purchase price. This means you'll need to accumulate more shares at lower than average prices, which is what this whole DCA business is about. And haphazardly throwing money into stocks that "look good to me right now" is the antithesis. How can this be done without buying on dips? No one can manually do with any consistency what this system does automatically: Buy more shares on price dips.
Another element in DCA is time horizon. Most financial planners will wisely advise against buying stocks/funds with money that can't be locked up for at least 5 years. So if you're not planning at least 5 years out, you shouldn't be in stocks to begin with, and if you ARE planning at least 5 years out, DCA would optimize the plan.
Going a step beyond that, if you have a 5 year or longer time horizon, it would be wise to change your initial allocation only once a year. Again, the theme is LONG TERM CONSISTENCY. If you have a gob of surplus cash fall out of the sky to invest, preserve it in cash/bonds, then wait and deploy that capital at next years reallocation or maybe even divided per year successively any number of years out. But DO NOT unbalance the plan by dropping a chunk of capital in your funds at once. Let DCA slowly work it into the system.
It's beyond the scope of this article to get into the right time to sell, but DCA can play a valuable role at that time. Not surprisingly, it's best to withdraw as consistently as you deposited. Incorporating that idea into your exit strategy will let the system retain value in your holdings. That's why it's good to know your exit plan when you set up your initial plan from the outset. Plan as far ahead as possible. It never stops working for you!!
Another element in this whole boring machine-like system is fund choice. Pick a good solid fund and stick with it. Any changes beyond your once yearly reallocation will only dilute the effect of DCA. Index Funds are excellent combined with DCA because it adds consistency to a system that's all about consistency.
DCA isn't exciting, and it is a rigid inflexible way to invest, but if you can stay the course, it is clearly an unbeatable strategy. There are a lot of wealthy retired folks out there that got that way by letting this brilliant system take care of their nest egg.
18 wheeler driving musclecar guru. Residing in the pacific northwest.
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