Financial Planning Fridays #55: Dollar Cost Averaging

What happens when you make an investment at the worst possible time; right before a decline of 20% or more? The answer will surprise you.

The market can be incredibly daunting. There are so many unknowns because no one knows the future. It can be soaring at all-time highs, Or it can be plummeting rapidly, dropping 20, 30, even 50% from its previous high. And, perhaps the worst part, no one knows when or why this will happen but when it does change course, it seemingly happens in an instant.

However, this is a fear that all investors need to overcome. The stock market is currently made up of the most successful, innovative, and profitable companies that have ever existed in the world. And those companies have provided an average return of more than 10% per year for the past 100 years- by far the best way to grow your family’s wealth and accomplish financial goals that you never could have imagined reaching.

For this reason, in this episode, we wanted to discuss one of the best ways to ensure that you do not miss any coveted time in the markets and how to develop a plan to put your cash to work in a methodical, disciplined manner.

Dollar cost averaging is investing a set amount of your savings into your investment allocation every month on the same day until your savings are fully invested no matter what the market is doing during that time.

Ideally, we all get the chance to invest our money right at the bottom of the market before it takes off into a new bull market. But, because no one can predict this, let’s focus on investing at market peaks instead, arguably the worst time to enter the market.

Over the past 43 years, there have been five market peaks, that at the time, would have been the worst times to make a new investment. What did it look like if you had invested just before the market peaked before declining by more than 20%? Brutal. Your fear has just been realized. You invested at one of the worst possible times.

In this chart, we review the results of investing the same amount on the 1st day of each month in the S&P 500 during the decline, and beyond, for 1, 3, 5, and 10 years. As a reminder, you are starting your investment plan right before the start of a major 20%+ market decline.

On average, your investment plan would have lost 1.8% in the first year, before rebounding to grow 5.8% per year by year 3.

Furthermore, looking at the returns for 5- and 10-years – all of the investment plans are positive with a return of about 12% per year!

The real risk wasn’t in your investments losing money, or facing a temporary decline; the real risk was in not making the investment at all and missing out on a 12% average annual return!

Be on the lookout for our next Financial Planning Fridays episode. Subscribe to our Youtube Channel so you never miss an episode. Or contact us directly; schedule your 15-minute call with us today.