Dollar Cost Averaging
An excellent long term investment strategy is called dollar cost averaging. This is a systematic method to invest for the long term. I’m assuming you’ve created your budget, have your spending to a level that you are saving every month and have created your emergency savings account. Now you can begin to invest for the long term. In simple terms dollar cost averaging is a long term investment strategy that promotes regular, periodic investing of a fixed amount over time. Most often the period will be dependent on when you receive your paycheck. The contribution amount will be a direct result of the budget you have created but can be done for as little as $100 a month. An appropriate investment vehicle to begin with would be a growth mutual fund. Mutual funds are set up as a diversified and professionally managed portfolio of investments. As the word implies (mutual) your money is pooled with lots of other individuals and institutions. The manager of the mutual fund decides where and when to invest the funds. Your money is segregated into your own personal account and as you buy every month you accumulate shares of the fund. Shares are your evidence of ownership. Each month as you dollar cost average you buy more shares.
Whether the markets are up or down you consistently and UNEMOTIONALLY invest your monthly amount. This provides a great benefit over time. As a young adult you likely have 30 to 40 years to accumulate wealth using this method. This extended period of time, your “investment horizon”, is your best friend at your age. You have a number of years to put money away the result of which, will hopefully be, a substantial total that you can enjoy in your later years. Additionally you have reduced the stress of investing in the market by taking the emotion out of investing. You simply plug away with your regular investing routine and let the market do the work of making money for you. Take the 2008 stock market as an example. The market collapsed largely because of failures in the real estate market and the banks that issued real estate loans. It was a time of great fear and turmoil. Investors were paralyzed. However, if you were dollar cost averaging (investing in more shares every month regardless of price) you were purchasing shares at bargain prices and accumulating more and more shares for your money. As the markets improved in 2009 you began to see the advantage of staying the course with your investments. Not only did those ‘cheap’ shares increase in value but you had more of them because you had purchased them at depressed prices. It’s easy to get scared and not participate in the markets when they are down but, as a young person, with time on your side, you should consider these lower prices an enormous gift. Focus on accumulating as many shares as possible and stick with your plan!
Alternatively there will be times when the market is high and you will not get as many shares for your money. That’s fine. Just remember the ‘average’ in dollar cost averaging. There will be high times and low times but dollar cost averaging spreads your cost over many years reducing your overall risk of investing at the inopportune time and helping to protect you from fluctuating market prices.
If you happen to be employed by an organization that offers a retirement plan this sweetens the dollar cost averaging deal. Retirement plans, by definition, are long term in nature. Most company plans offer a variety of investment choices with which to invest. Most of these investment options are mutual funds. You determine how much is taken from your check each period to invest in your retirement account. Identify and invest in appropriate mutual funds from your investment choices and you’re off and running on your retirement goals. An added advantage of investing through a retirement plan is earnings on your investments are not taxed until you begin to withdraw the money many years from now. The beauty is once you’ve established a periodic investment amount and selected suitable mutual funds (focus on the growth funds) it becomes automatic. You don’t miss the money because it isn’t available for you to spend. Over time you will be amazed at how much you accumulate during good times and bad.
I have mentioned mutual funds several times and I want to explain how they work. Mutual funds are by definition a diversified portfolio of investments chosen by professional money managers. The word mutual means there are a lot of people, just like you and me, that place money into these investments. The mutual fund collects these monies and hires professional money managers to decide where to invest the capital. In general, a growth mutual fund could have as many as 200-300 different companies within its portfolio. The advantage of a mutual fund is, for a small amount of money, you receive a range of diversification you would otherwise not be able to attain as an individual investor. Diversification simply means that your money is spread over a variety of investment categories – commonly known as Asset Classes. Examples might be Large Cap Growth Stocks, International Stocks, Government Bonds, Real Estate, etc…
An additional advantage of mutual funds is investment professionals make the buy and sell decisions for you. They have research teams which visit companies and do extensive analysis to determine what they believe to be the best companies to own within the mutual fund. Most company retirement plans offer a variety of mutual fund choices where you may invest your retirement money. For most people mutual funds are an excellent way to create wealth over time with less risk and less headache.
- Invest monthly – whether on your own and/or within your company retirement plan
- Invest during good times and bad – when the markets are down, you accumulate more shares at inexpensive prices
- Focus on growth mutual funds as you have lots of time to let the money work
- Invest for the long term