By Yann Kostick from the August 2012 Edition
You have heard of dollar cost averaging: the process of making investments at regular intervals over time. But have you tried it? You may find it worthwhile because it can be an effective investment strategy.
Dollar cost averaging establishes discipline; you build a habit of regular investment to help you reach your long-term goals. And by investing regularly over time, you’re not worried about trying to time the market.
In fact, it can help you take advantage of market fluctuations. Because you invest the same dollar amount each period, you typically purchase more shares when prices are low and fewer shares when prices are high. This means that over the entire purchase period, your average cost per share could be lower than the investment’s average price per share.
Dollar cost averaging works for just about any type of investor with any amount of money to invest, and it can be a great way to ease into investing because you can start with a relatively small amount of money.
But as you guessed it, it’s not that simple. On one hand, that would have worked well for you in the past decade: while total returns on U.S. stocks averaged only about 2.5 percent annually from year-end 2000 to year-end 2011, according to the Investment Company Institute, you could have benefited from the dramatic moves we experienced during these past ten years, and done quite well. On the other hand, today poses a new challenge: if you have a large sum to invest (such as an inheritance, rolling over 401 K or proceeds from the sale of a home), you can no longer put it into a savings or money market account while waiting for the strategy to be executed, since interest rates are so dismal that you will not see any returns. And the longer interest rates stay low (which looks like that they will), the bigger of an issue drawing down principal will become upon or during retirement.
I can hear you say “Bonds”: well that has been true in the past, with a total return on bonds of 6 percent annually in the past 11 years, investors in fix income have been rewarded, but eventually interest will return to more ”normal” levels, and fixed income investors will feel the pain.
Dollar Cost Averaging is still worth considering. Of course, deciding whether to use a dollar cost averaging strategy depends on your individual financial situation. Your advisor can help you make the right choice.
Yann Kostic is a Money Manager and Registered Investments Advisor with Atlantis Wealth Management specializing in retirees (or soon to be), self-reliant women and Expats. Yann works with TD Ameritrade Institutional as the custodian of client’s assets.
He splits his time between Central Florida and the Central Pacific Coast of Mexico. Comments, questions or to request his Newsletter “News You Can Use” Yannk@AtlantisWealth.com