The market sucks right now. This week alone the Dow has suffered two days with 300+ point drops. Analysts are getting their names in the headlines with all kinds of bearish predictions for 2016, everything from calling for another flat year like 2015 to outright doomsday scenarios.
It’s understandable if you’re considering staying on the sidelines and waiting out this volatility, especially if you have a sizable chunk of money you don’t want to put at risk.
But not investing in stocks when the market is doing poorly is a bad decision. The only thing worse is selling the stocks you already own.
Rather than selling stocks when the market is sputtering, this is the time to buy more. Since the stock market has never gone anywhere but up over the long-term, bear markets should really be called discount sales. Since your shares will almost certainly be worth more in 10 years than they’re worth this year, why not buy them now when they’re cheaper than what your buddy paid for the same shares a month ago?
If you’re reticent about investing a bunch of money at once into a turbulent market, that’s understandable. But that doesn’t mean you should sit on your money and try to “guess” the market bottom — as the saying goes, a blind dart-throwing chimpanzee has a better chance of getting it right.
Fortunately, there’s a method by which you can minimize your exposure to short-term losses and also maximize the chance of getting some money into the market at its true bottom. The method is called dollar cost averaging.
Dollar cost averaging sounds like a fancy finance term, but the concept is simple enough for a second-grader to understand. You take the amount you have to invest, divide it by the number of months (or quarters or years, but I recommend months) over which you want to invest it, and invest the resulting amount per month until it’s all invested.
So, if you have $18,000 and want to invest it over a year and a half, you would invest $1,000 per month for 18 months. Simple.
It’s great because if your fears turn out correct and the market drops over the next few months, most of your money misses out on that fall. It also means that whenever the market nadir happens, you’ve got some money going into the market that month. If you’re wrong and the market starts rising, you don’t miss out on any cheap stock like you would if you sat on your money.
Investing a fixed amount of money each month ensures that you buy more shares when the price is low and fewer shares when the price is high. This lowers your average cost per share, which increases your total return when the market turns upward. Dollar cost averaging also reduces the risk of timing the market wrong and investing too much money during a market peak. Remember, even Warren Buffett, the greatest investor in the history of investing, says that you can’t beat the market. Believe him.
Dollar cost averaging confers a psychological benefit, as well. Even when logic tells you that dips in the market represent perfect buying opportunities, it can be hard to pull the trigger when you’re consumed by headlines predicting financial armageddon. The screaming idiots on cable news love to take the slightest agitation in the market and use it to paint an end-of-times picture. Just remember that if it bleeds it leads; the media prefers to disseminate bad news because, unfortunately, bad news is what sells.
The negativity surrounding a down market can get in your head and cause you to miss a great buying opportunity. You know it’s a good time to buy, but a little voice in your head (or a loud, shrill voice on CNBC) tells you that you’re crazy. The voice wins out, and you miss a huge upswing. Here’s where the beauty of dollar cost averaging comes in. It’s a set it and forget it system. Once you figure out the numbers, you can set up automatic transfers from your bank account to your brokerage account each month and then forget about it. You don’t have to marshal the courage to write that check or transfer those funds when the world seems to be telling you not to.
Whenever the stock market takes a dip, two things happen: Stupid people sell their stock. Smart people buy more stock. Dollar cost averaging ensures that you’re one of the smart people. Don’t sit on your money out of fear. Invest it using dollar cost averaging and know that whatever the tempestuous, mercurial, unpredictable market decides to do next, you’re going to get some money in it at the perfect time.