Does it work in a down market?
Here’s a novel idea, buy low and sell high. This is perhaps the oldest saw in the stock market. However, in the wake of the recent sell-off, dollar cost averaging may provide you with the opportunity to capture lower prices today. Although dollar cost averaging can’t protect you against market loss or guarantee investment gain, it does eliminate the need to time the market.
How does it work? Dollar cost averaging (DCA) is a long-term investment strategy. It means investing in small increments. Through scheduled investments of as little as $50 or $100 per month, you buy investment shares over time, as opposed to pouring a big lump sum into the market. This method of investing is often recommended to younger investors with longer time horizons, and investors who don’t yet have great wealth.
But it can work for everyone. Also, some investments have a minimum requirement of $1,000 or more but will allow a small purchase if you invest on a periodic basis.
Why is it worthwhile in a bear market? First of all, when the market drops, the investor practicing dollar cost averaging may not experience as big of a decline as the lump sum investor – as the lump sum investor holds many more shares of the declining fund or stock. The volatility that drives investors crazy, as they see the value of their portfolios plummet, is a friend of the DCA investor.
Second, a stock market downturn produces a kind of “clearance sale” environment. Picture Wall Street as a department store, with signs everywhere announcing 20 percent or 30 percent off. You have a chance to buy into some top-quality companies “on sale.” As a result of dollar cost averaging, you can now buy in at a lower price – and buy more shares for your money.
Another advantage of DCA is that by buying shares at different prices over time, your purchase price is below the average share price.
So what happens when the market recovers? As the market rebounds, you can pat yourself on the back. You were able to buy big at the bottom of the market, and as the market rises, you will have a lower cost basis. All the while, you continue contributing to a winning fund or stock. (Of course, the fact is that a lump sum investor may profit even more from a market rebound, as he or she may hold comparatively more shares than you.)
Perhaps most importantly, you stay invested. Dollar cost averaging gives you a regular, passive investment strategy as opposed to market timing. In a volatile market, the active investor can quickly become a frustrated casualty of his or her impulses – and foolishly “abandon ship.”
Think of a tortoise-and–hare analogy. The active investor sprinting all over the place for spectacular gains is the hare: You, through dollar cost averaging, emulate the tortoise. It may not be the “sexiest” way to invest, but in a down market, it is a long-term approach well worth considering.
We have witnessed huge downturns in stocks. The question is, “How are you positioning yourself to potentially take advantage of the markets when things rebound?” This is a good time to review or rebalance your portfolio, to look past the headlines of the moment and toward your long-term objectives. If you’re not currently practicing dollar cost averaging, you may want to consider the concept. (Dollar cost averaging does not assure a profit or protect against loss in declining markets.)
Declining prices do not assure that they will recover and increase. Dollar cost averaging involves continuous investment in securities regardless of fluctuation in price levels of such securities. An investor should consider their ability to continue purchasing through fluctuating price levels. Such a plan does not assure a profit and does not protect against loss in declining markets.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for the individual. Randy Neumann, CFP® is a registered representative with and securities and insurance offered through LPL Financial. Member FINRA/SIPC. He can be reached at 600 East Crescent Avenue, Suite 104, Upper Saddle River, NJ 07458, 201-291-9000.
