Are you thinking about investing your hard-earned money?
You should be. It’s the way to gaining long-term wealth.
One of the best places to start is the stock market in an index fund.
But it matters how you buy the index fund.
What if I told you that you can save $3,802.66 just by the way you buy the index fund?
You’d be interested right?
And no, I’m not selling anything.
It’s called dollar-cost averaging and it’s almost magical.
Let me show you what I mean.
What is Dollar-Cost Averaging?
It is a investment buying strategy where you invest a fixed amount of money every month.
For example, if you have $12,000 to invest, you put in $500 every month for 24 months.
This is instead of investing $12,000 all at once.
I bet I can guess what you are thinking right now.
Your thinking if you did this you would miss out on all the upside to the market.
And that’s a fair argument.
You would also take less of a beating in a falling market.
But let’s look at some examples before we decide if this strategy makes sense.
Entering a Market Going Down
Let’s look at the worst market in recent memory.
It’s October 1, 2007 and you have $12,000 to invest.
You want to just buy the Dow Jones Industrial Average Index.
So you put all $12,000 in on October 1, 2007.
How did that work out for you?
Not so well. By September 1, 2009, your $12,000 is now worth $8,197.34.
Ouch. You lost $3,802.66.
But what if you invested that $12,000 over 24 months by putting in $500 per month?
The results are dramatically different.
With the same starting point of October 1, 2007 and ending point of September 1, 2009, your $12,000 is now worth $12,531.27.
You just came through the worst market in recent history and made it out alive.
That’s just based on how you buy.
Meanwhile it’s another 3 and a half years before you break even if you invested $12,000 up front.
Entering a Market Going Up
But there’s a flip side. What if the market is going up?
Let’s look at another example.
I’ll even pretend you timed the bottom of the market perfectly.
On March 2, 2009, you decide to enter the market.
You take your $12,000 and buy the Dow Jones Industrial Average.
Two years later on February 2, 2011, your $12,000 is worth $20,223.96.
Not bad, you made $8,223.96.
Your gamble paid off.
But what if you put $500 in a month for two years like we did above?
On February 1, 2011, you investment would be worth $14,650.57.
That’s pretty good too. You make $2,650.57.
You still made money but not quite as much.
More than likely, your scenario will be somewhere between these two extremes.
But I used extremes to illustrate a point.
In a market that’s going down, you are a lot better off using dollar-cost averaging.
In a market that’s going up, you are better off jumping in head first.
The problem is you don’t know where the market goes until after it gets there.
And jumping in head first in a down market is much more painful than missing out on some additional gains.
You can do what you want but I am dollar-cost averaging my investments.
I’m a defensive guy anyway.
Which method do you prefer?
Click the link to return to Finance Footing home.