Tuesday, January 19, 2016

Dollar cost averaging our investments during market volatility

The market over the last 3 months
For those following the stock market, things have been getting very volatile.  In just the first few weeks of the new year, US Stocks are down about 8% and international stocks are down even more.  The financial news headlines make it sound like we’re going back to another recession.  We’ve lost over $16,000 in our portfolio in just the last few weeks.
Here’s the thing with investing in stocks: there will always be risks.  On any given day, the market may go up or it may go down – affecting your portfolio value.  Many investors rush to buy when they hear how the stock market is doing well (paying high prices) and then sell when they hear how the stock market is doing poorly (selling low).  Paying high prices for stocks and then selling off stocks at low values is a good recipe for financial ruin.  
No one can predict the future of the financial markets: not tomorrow, next week, next month, next year, or the next ten years.  Tomorrow your investments may plunge in value – or they may soar.  Any decrease in your portfolio is only a paper loss.  You still own all of the index fund shares that you’ve purchased.  You only really lose money when you sell at a loss, and lock in your paper losses.  If you are investing for the long-term, short-term market fluctuations really should not worry you.  No one out there can consistently time the market.  But that’s okay, because you don’t have to time the market perfectly to be a good investor.     
The market from 1928 until today
The long-term trend has been that the market always pushes further upwards.  If you are diversified in your investments, you can count on them to reward you in the long run.  Most decreases in your portfolio are only temporary and eventually rebound.  Our investments are made up of 90% stocks (70% US stock market, 30% international stock market), and 10% US bonds.  This includes over 6,100 US stocks, over 6,400 international stocks, and over 5,800 bonds.  We are comfortable with this asset allocation and we sleep well at night knowing that we are well diversified.  
If you find yourself in this situation, the value of your portfolio doesn't matter
Worst case scenario, if the stock market really loses ALL of its value, and ALL of the companies collapse, it will be the end of money.  Even cash saved under the mattress will have no value.  If such a meltdown occurs, the only thing you can count on will be your own survival skills, food, shelter, and weapons for protection.  Losing portfolio value will be the least of your concerns.  I don’t see that type of apocalypse happening anytime soon.  Remember: life is long, plan accordingly.           
So now that the market has been down to start the year, is it a good time to pick up some shares of your favorite index fund(s)?  I say that it’s always a good time to invest.  The returns on the very first few weeks of a market recovery produce a large proportion of the total gains that will be experienced.  If you don’t stay invested, you miss out on those gains.
Even in the face of a crash, you can still contribute money in smaller portions by dollar cost averaging your investments.  If you have a large sum of money that you would like to invest, consider investing equal amounts of money regularly over time instead of all at once.  By dollar cost averaging your investment purchases, you will be able stay consistently invested.  It hurts a lot more to invest a large sum at once, only to watch it lose value and take longer to regain your losses.    
When the market is volatile, dollar cost averaging can reduce the risks of buying into a falling market.  As the value of the funds you want to buy go down, you end up picking up more shares of the asset for less money.  Buying stocks now saves you 8% compared to buying stocks 2 weeks ago.  If the stock market continues to fall, you can continue to pick up more and more shares at cheaper sale prices – definitely something to get excited about on your journey towards financial freedom. 
These cheaper share prices will reward you in the future when their value rebounds.  Invest early and invest often.    
Note: two-thirds of the time, lump sum investments produce greater returns in the long run than dollar cost averaging.  Psychologically, buying when the stock market is falling is more satisfying than watching a large investment drop in value.  This being said, most investors like ourselves are already dollar cost averaging and investing as we earn. 

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