By Matthew Gaude & Shawn McGuire
The last couple of months have been a difficult time for stock market investors. After reaching record highs in February, the market went on a COVID-19-driven roller coaster ride. There were a lot of people wondering if they should just cut their losses and get out. Or at least stop putting money into their investments until things calmed down.
While it sounds like a sensible thing to do, that’s the last thing you should be doing right now. There is no way to know when things have calmed down, and while it seems counter-intuitive, a down market is the best time to be putting money into investments. It never works to try to time the market, but dollar cost averaging (DCA) is a good way to make sure you don’t miss out on the opportunities that present themselves in times like these.
What Is Dollar Cost Averaging?
Dollar cost averaging is simply investing a fixed dollar amount on a regular basis. No matter what is going on in the market, you continue to contribute the same amount of money to the same investment.
A common example of this is automatic 401(k) investing. You may set it up so that a certain percentage of your pay or a certain dollar amount comes out of your paycheck each period and is invested into your 401(k). The same amount is invested regardless of how the investment itself is performing or what your money is able to buy you.
The Effect Of Down Markets On Dollar Cost Averaging
Because the dollar amount of your investment is fixed, the amount of the investment that you are getting fluctuates. For example, let’s say that you are investing $600 each month into a specific company’s stock. When the stock is selling for $100 a share, you get 6 shares that month. If the price drops to $80 a share the next month, your $600 will get you 7.5 shares. If the price were to drop in half, to $50 a share, you would get twice as many shares (12). If the stock goes up in value to $120 a share, then your regular $600 investment will only purchase 5 shares for you.
As you can see, with dollar cost averaging, down markets mean that you get more for your money. You are able to buy more shares of stock with the same amount of money and when prices recover, then your investment portfolio is worth even more. When you buy a share of stock at $50, you have the potential for a much greater return than when you buy it at $100. When your $100 share increases in value to $120, that is a 20% increase in value. However, when your $50 share increases in value to $120, that is a 140% increase in value and you have twice as many shares experiencing that increase.
It’s obvious that your future returns would be greatest from the bottom of a nasty bear market but look at how much higher the ending dollar amounts are on all of those contributions that cluster around the financial crisis.
Even the contributions that were way too early or way too late in relation to the bottom can make a big difference. Even those who are fast approaching retirement could still see current contributions grow for the next two to three decades depending on their lifespan.
Plus there’s the fact that “waiting until the dust settles” is a strategy that has never worked in the history of the markets.
The beauty of dollar cost averaging is you don’t need to nail the bottom in order to succeed. Simply continuing to invest while stocks are far below where they were five weeks ago is much easier than trying to bottom tick the market.
What You Should Do
Clearly, now is not the time to stay out of the stock market if you have a long time horizon for your investments. While doing so may feel like the natural thing to do, dollar cost averaging can protect you from such emotion-driven decisions and help you take advantage of market downturns like the one we are experiencing.
Now is the time to determine if you are able to increase your 401K contributions if you are not maxing out your contributions this year. If you can buy more when the prices of stocks are low, or when the stock market recovers, you should see your 401K balance increase even more. You should be able to change your contributions at any time. For 2020, you can contribute up to $19,500 and if you are 50 years of age or older, you can contribute another $6,000 for a catchup contribution. These limits apply to both a Traditional and Roth 401K.
How are you feeling about your investments right now? Do you feel like you are taking advantage of this down market, or like the market is taking advantage of you? If you’re looking for an experienced advisor to help guide you through this trying time or would like a second opinion on your current portfolio, call our office at 770-552-5968 or email [email protected]. Or, if you prefer, you can simply click here to schedule an appointment online.
About Matthew
Matthew Gaude is an *investment advisor representative and the co-founder of Live Oak Wealth Management, a financial services firm in Roswell, Georgia. He serves the planning and investment needs of corporate employees, those approaching or in retirement, and 401(k) plan sponsors. Working first as a commodity broker and then as a Business Development Manager for a national broker-dealer in previous jobs, he has the insight and experience to help clients understand the complexities of the market and implement strategies to minimize risk. To learn more about Matthew, connect with him on LinkedIn or visit www.liveoakwm.com.
About Shawn
Shawn McGuire is a financial advisor and the co-founder of Live Oak Wealth Management, a financial services firm in Roswell, Georgia. He serves the planning and investment needs of corporate employees, those approaching or in retirement, and 401(k) plan sponsors. He has worked in financial services since 2002 in positions ranging from financial advisor to stock broker and portfolio manager. As a CERTIFIED FINANCIAL PLANNER™ professional, he is trained to help clients with virtually all their financial needs. To learn more about Shawn, connect with him on LinkedIn or visit www.liveoakwm.com.
Securities offered through American Portfolios Financial Services, Inc., member FINRA/SIPC. Investment advisory services offered through *American Portfolio Advisors, Inc., a SEC Registered Investment Advisor. Live Oak Wealth Management, LLC is independently owned and not affiliated with APFS or APA.
Any opinions expressed in this forum are not the opinion or view of American Portfolios Financial Services, Inc. (APFS) or American Portfolios Advisors, Inc. (APA) and have not been reviewed by the firm for completeness or accuracy. These opinions are subject to change at any time without notice. Any comments or postings are provided for informational purposes only and do not constitute an offer or a recommendation to buy or sell securities or other financial instruments. Readers should conduct their own review and exercise judgment prior to investing. Investments are not guaranteed, involve risk, and may result in a loss of principal. Past performance does not guarantee future results. Investments are not suitable for all types of investors. Seek tax advice from a tax professional.