If you find yourself worried about falling stock prices – but you do not want to miss out the market’s inevitable turnaround — here is a tried-and-true investing strategy to consider.
Dollar-cost averaging (“DCA”) is the strategy of spreading out your stock and bond fund purchases over time, buying at regular intervals and in roughly equal amounts. The idea is to get the best deal on a desired investment by controlling for market fluctuations. Instead of trying to time the market, you buy in at a range of different price points.
Done properly, DCA could provide significant benefits to your 401(k) portfolio. How? By “smoothing” your purchase prices and ensuring that you are not dumping all your money in at a high point while keeping your portfolio positioned for future growth.
Dollar-cost averaging can be especially powerful in a bear market, allowing you to purchase stock at low points when most investors are too afraid to buy (traders refer to this as “buying the dips”). Committing to a DCA strategy means you will be investing when the market is down, which is when investors often score the best deals.
How to use dollar-cost averaging to build a position:
- Decide how much money you want to invest in a particular investment option.
- Decide how often you want to make your investments.
- Decide how many periods you want to split your investments over.
- Divide the total dollar amount you want to invest by the number of desired time periods to determine the amount of each investment.
You may already be dollar-cost averaging if you are contributing regularly to a 401(k) at your workplace.
And do not forget…you can suspend the plan if you need or want to. The point here is to keep investing regularly, regardless of stock and bond prices and market anxieties. Remember, bear markets are an opportunity when it comes to dollar-cost averaging.
As I write this, stocks are rallying off some of the sharpest losses since the “Black Monday” market crash in 1987. In recent days, the S&P 500 has experienced its worst day in more than three decades, while the Dow has suffered its worst point drop ever. Both benchmarks – with more than 20% declines from their highs – have marked the official end of the longest bull-market run in history.
We will make no prediction about what will happen in the coming days, but we can say with certainty that while this market plunge has been scary, it is not so unusual in the long-term scheme of things. Since 1949, the market has, on average, declined 15% or more about once every four years, and 20% or more once every seven years.
With this rally, the bottom may very be in. It also, of course, may not. The truth is that no one really knows how the markets will react to ongoing coronavirus headlines, inevitable earnings declines at certain companies, and other unforeseeable events.
But history tells us the market has fully recovered from all of its past crises. We suspect it will do so again this time. In the meantime, take this time to review your retirement portfolio and make sure you are comfortable with its positioning. Always try to think about strategies like dollar-cost-averaging to reduce risk and still stay in the market.