25 Jul How Dollar-Cost Averaging Helps You Lower Risk
When it comes to investing, the passive portfolio wins. Over and over, studies reveal that active “traders” rarely beat the market. In fact, it’s mathematically impossible for the average investor to have above average returns.
Unfortunately, just understanding that a passive, long-term approach is best isn’t enough. We actually have to follow through with the strategy. With the economy constantly changing, this can be far easier said than done.
The solution to the temptation of trying to “time the market” is through a strategy called “dollar-cost averaging”. It allows investors to simply automate their investing in such a way that every month, they’ve purchased more gold and silver — without having to manually, consciously buy in a lump sum.
Doing this provides a very easy, simple, less stressful method for investing passively over time. In the end, for the passive investor, automation is a vital ally.
What is Dollar-Cost Averaging?
Dollar-cost averaging is when you decide to invest a certain dollar amount into an asset, regularly, over time, without attempting to time the market on any level.
There’s quite a bit of debate about exactly what dollar-cost averaging entails. Some, for example, claim that it’s not necessarily the same thing as investing regularly, but should be defined as when someone has the ability to invest a lump sum, but instead decides to invest small amounts regularly over time.
Either way, the point is still the same. Dollar-cost averaging is a good call for almost all investors because it makes investing much simpler, cuts stress, and reduces the risk of picking the “wrong” time to invest.
Let’s go over the most important reasons to go with dollar-cost averaging over the alternatives:
Calm approach. Investing and saving are just as much about psychology as they are about numbers and figures. An investment strategy that requires less upfront “commitment” and can easily be automated is a strategy that is more likely to end well — rather than lead to an overreaction.
Less of a shock. After investing in an asset, it’s not that rare for the price to jump or fall immediately afterwards. To many investors, this jolt is horrifying, and often encourages them to reject passive investing overall, and try to time the market as a reaction. This is a costly mistake.
A bird in hand. Part of investing is doing what’s necessary to cut the possibility of a large loss. Taking a slight loss in order to avoid a possible larger loss can be a great idea. To an extent, dollar-cost averaging uses this same strategy. It averages out the market’s returns over time rather than gambling that “now” is actually the best time to invest.
Dollar-Cost Averaging or Lump-Sum Investing?
Many investors will never face the dilemma of what to do when investing a large sum of money. For most, they’ll be dollar-cost averaging essentially by default — investing regularly over time is their only real option.
But for others, running into a large sum of money and planning what to do with it is a very real issue. For those individuals, all of the above points still completely apply. Dollar-cost averaging allows you to ride the price of the asset you’re investing in over time, without taking any large risk from incorrectly timing the market.
Sometimes, dollar-cost averaging doesn’t just cut risk; it can greatly increase your returns. For example, this short example from Russell Investments explains how dollar-cost averaging would have greatly helped during the 2008 financial crisis:
“See the impact of Alice’s lump sum investment in super versus Bob’s regular contributions after one year.
Back in January 2008 the markets had fallen. It looked like a good time to buy in at a cheap price, so Alice decided to put $12,000 into a balanced fund. Bob however, was concerned that the markets could fall further, but wanted to be in a position where he could benefit from a market recovery. He decided to invest $1,000 a month in the same fund for one year.
Over this time the markets fell further, so both Alice and Bob saw a drop in the value of their portfolio. As unit prices dropped, Bob bought more units each time he contributed. Alice’s investment was $9,160.36 at the end of December and Bob’s was worth $10,114.48. Because Bob purchased more units in total for the same amount of money, his portfolio will increase more in value as the market recovers.”
Not only are the returns more stable and less stressful, but in many circumstances, they can save the investor from massive losses. This is exactly the kind of strategy we should be looking for.
Finding more profits doesn’t always require more risk — sometimes, you can have both. It’s all about the strategy used.
Invest Automatically and Regularly
As we’ve discussed in the SilverSaver® guide, in our article on passive investing, and in our article comparing investing and gambling, cutting the chances of having something go very wrong is part of a successful long-term strategy.
Investors often get caught up in the heat of the moment and make huge choices that end up wiping out decades of hard work, sacrifices, and savings. That’s not a position anyone wants to be in.
That’s why SilverSaver® focuses on helping regular investors amass wealth and save real money by using passive investing, dollar-cost averaging, and investing in the only “money” that has survived the test of time.