Reluctant to invest in a volatile market? Why a regular savings plan, and dollar cost averaging, may be your answer.
Whether your financial dream is to have sufficient funds for your retirement, your child’s university education, or your dream wedding and house, take comfort knowing that a disciplined investing approach with a regular savings plan can help you in a powerful way. A regular savings plan helps instill financial discipline as you are forced to save on a monthly basis.
The basic idea of investing well is simple: buy when the market is low and sell when it’s high. However, even the most sophisticated, experienced investors have a hard time trying to perform such a feat consistently.
This is because investment markets tend to be volatile – rising and falling suddenly for reasons which are often unexpected. It is this volatility, though, which also creates the potential for returns. By taking a disciplined approach to how you invest, you can make volatility work for you, ride out periods of poor performance, and achieve smoother returns over the long run.
Instead of investing all your money at once, try a steady approach, investing a set amount over a set period. This way of investing is known as Dollar Cost-Averaging and is a fundamental feature of regular savings plans. By using this method, you will be able to turn market volatility to your favor by harnessing the power of this simple, yet highly effective investing principle.
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How it works
Cost Averaging refers to the practice of building investment positions by investing fixed dollar amounts at equal time intervals, as opposed to investing a lump sum all at one time. It can be especially helpful during lengthy bear markets because the market is down or flat for a more extended period of time.
One benefit of investing the same amount of money at each interval is that you’re buying more shares of whatever asset you’re buying when the price is low and fewer shares when the price is high. The dollar amount remains the same, but the share volume goes up and down with the market.
For example, investing in the S&P over the last 20 years produced an annualized return of 7.2%, but missing just the top 10 days in those 20 years cuts the return in half, to 3.5%. Investing on a regular monthly basis means investors aren’t missing out on those top 10 days if they get concerned during a downturn.
Dollar cost averaging also enables new or less experienced investors to get started with a relatively small amount of money.
You don’t have to wait until a large lump sum is available because you’re investing smaller set amounts of money into the fund or asset continually throughout the year. The strategy also means you’re continuing to invest toward your goal rather than stopping and starting repeatedly.
By staying invested, you are more likely to achieve your goals. This strategy is particularly useful in a volatile market because you reduce the risk of accidentally investing all your money when prices are high. The key is to buy low, so by spreading out your investments throughout the year; you’re not investing everything right before the market falls.
Another benefit is that it can be an effective way for investors to mitigate one of the practical flaws of lump-sum investing – the mind’s tendency to make counter-productive decisions that are driven by loss aversion and volatility-induced emotions. It ensures that investors aren’t just responding to their emotions by selling high and buying low.