To remain financially responsible, everyone must pay bills on a
regular basis. These bills include mortgages, utilities, car loans,
and credit cards. Unfortunately, many people do not also heed the
oft-quoted advice to pay themselves first.
The harsh reality these people may discover is that a steady
saving and investing plan is sometimes necessary to help pursue
such financial goals as paying for a wedding or new car, buying a
house, and funding retirement. Financial experts disagree on the
ideal way to invest in order to meet such goals, but one strategy
can help you develop a systematic investing plan while potentially
saving you money and easing your mind along the way. It's called
dollar-cost averaging (DCA).
Periodic investment plans do not assure a profit and do not
protect against loss in declining markets. Dollar-cost averaging is
a strategy that involves continuous investment in securities
regardless of fluctuating price levels of such securities, and the
investor should consider their financial ability to continue
purchasing through periods of low price levels.
The chart compares the performance of a $12,000 lump-sum
investment in stocks to the performance of a $12,000 portfolio that
was reallocated gradually from a money market investment to stocks
in a dollar cost averaging strategy.
Source: ChartSource®, DST Systems, Inc. For the
period from January 1, 2009, through December 31, 2018. Stocks are
represented by the S&P 500 index. Cash is represented by the
Bloomberg Barclays U.S. Treasury Bill 1-3 Month index. Dollar-cost
averaging does not guarantee a profit or protect against loss.
These plans involve continuous investment in securities regardless
of price levels. You should consider your ability to continue
purchases through periods of increasing or declining prices. It is
not possible to invest directly in an index. Index performance does
not reflect the effects of investing costs and taxes. Actual
results would vary from benchmarks and would likely have been
lower. Past performance is not a guarantee of future results. It is
not possible to invest directly in an index. Past performance is
not a guarantee of future results. © 2019, DST Systems, Inc.
Reproduction in whole or in part prohibited, except by permission.
All rights reserved. Not responsible for any errors or omissions.
Dollar-cost averaging is a technique often used in buying mutual
funds in which investments of defined amounts are made on a regular
basis. As a long-term, disciplined strategy, DCA can help you take
advantage of the benefits of compounding to potentially build a
sizable sum. Consider the accompanying chart, which shows the
hypothetical result of investing $50 every month for 12 consecutive
months at the indicated share price.
The Benefits of DCA
|AVERAGE PRICE PER SHARE:
|AVERAGE COST PER SHARE:
Other Long-Term Benefits of DCA
Another potential benefit of using DCA is that it ensures that
your money purchases more shares when prices are low and fewer when
prices are high. Over the long term, the result could be that the
average cost you pay for the shares may be less than the average
price. Assume you invest $50 per month in an investment for 12
months and every month the share price fluctuates a bit. You can
see that your $600 total would have bought you 42.7 shares. The
average price per share, as calculated by adding up the monthly
prices and dividing by 12, would have been $14.25. However, the
average cost that you would have actually paid, as calculated by
dividing the total amount invested by the number of shares, would
have been $14.05 per share. Over the years, this method could
potentially save you a lot of money.
In addition, DCA can offer the psychological comfort of easing
into the market gradually instead of plunging in all at once.
Although DCA does not assure a profit or protect against a loss in
declining markets, its systematic investing "habit" helps encourage
a long-term perspective, which can be soothing for people who might
otherwise avoid the short-term volatility of the riskier, but
potentially more profitable, investments, such as equities.
And last, DCA may help you make savvy investment decisions if
you stick with it. For example, if your investment rises by 10%,
you will likely post big gains because of the shares you've accrued
over time. And if it declines by the same amount, take comfort in
knowing that your next investment will purchase more shares at a
less expensive price -- shares that may regain their value and even
exceed the higher price in the future.
Some Experts Say DCA Is Not the Best Strategy
Although investing a regular amount each month may be a sound
way to develop a regular investing habit, some experts say that it
may not be the best way to manage a financial windfall, such as an
inheritance, a bonus, or even lottery winnings. A landmark study by
Peter Bacon and Richard Williams, professors at Wright State
University, suggested that investing such a lump sum all at once as
soon as it is received reaps greater financial rewards than DCA,
albeit at a higher level of risk.1
The study tracked lump-sum vs. systematic investments over 780
different 12-month periods from 1926 through 1991. Results
indicated that an investor would have fared better 64.5% of the
time by investing his or her money in a lump sum. This implies that
if you have a large sum of money earmarked for the stock market, it
should be put to work as soon as possible. Though past performance
does not guarantee future results, stocks have historically risen
the most over time.
Remember, however, that markets change over time, and this study
may have yielded different results in more recent years. And, while
you evaluate the relevance of the study to your investing needs,
also consider the following situation: If you're 65 years old and
you receive a $300,000 401(k) distribution, can you afford to take
a chance that the market will drop shortly after you invest your
retirement proceeds? If there's a sustained market decline, two
years thereafter you might discover that your $300,000 life savings
would be worth only $200,000. Over time you might recover your
investment, but you have to weigh the consequences of loss before
choosing lump sum vs. DCA.
Regular Investing Makes Sense
While investing a lump sum at the most opportune time can
potentially profit you more than if you dollar-cost average your
investment, defining "opportune" is difficult for even the most
seasoned experts. As a long-term strategy, you may find DCA to be
more appropriate to help potentially lower your average cost per
share, and allow you to feel more comfortable during uncertain
markets knowing that you made sound investment decisions. Keep in
mind, however, that you should consider your ability to purchase
over long periods of time and your willingness to purchase through
periods of low price levels.