First of all, this is a long-term investing style, if you are not that kind of person then it’s not for you.
Let’s say you can spare $500 a month. By allowing dollar cost averaging into just 3 index funds, $300 into one that holds total US stock market, $100 into once that hold foreign stock market and $100 into one that hold US bonds – you can say you hold almost every investment in the world that’s worth owning.
Every month you buy more
If market has dropped your present investment now have more value, so now you buy more shares than before
If market goes up your money buys you fewer shares
By making this strictly disciplined investment at start of every month, you prevent your emotions from putting more money in market when market is very high ( and it’s very overvalued) and refusing to buy more after market has crashed and now ( things are cheap but for speculators now it’s risky)
According to Ibbotson Associates, the leading finical research firm, if you invested $12,000 in s&p 500 stock index at beginning of SEP 1929, 10 years later you would have only $7224 left but if you started investing $100 every month then buy August 1939 you would have made $15,571. THAT’S THE POWER OF DISCiPLINE BUYING AND EVEN IN FACE OF GREAT DEPRESSION AND WORST BEAR MARKETS (2007). YOU CAN MAKE MONEY WHEN ALL OTHERS ARE LOSSING, PROVIDED THAT: 1. YOU INVEST IN INDEX FUNDS ( FOR DIVERSIFICATION) NEVER INVEST IN A SINGLE STOCK 2. YOU DO INVEST NO MATTER WHAT AT START OF EVERY MONTH 3. HAVE ATTITUDE TOWARDS MARKETS OF “I DON’T KNOW WHERE IT’S GOING AND I DON’T CARE”
Couldn't agree more, Long term investors almost always out perform traders or speculators!
kaylbee
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Just for fun, I took a different time frame to see how averaging in does during a bull run. 1990-2004 (mostly bull run with a couple years of bear market). I started with $15,000 and could a) in January 1st, 1990 spend all $15,000 on the S&P 500 or b) spread out the $15,000 buying $1,000/yr in the beginning of January of that year. If you bought it all-at-once, you wind up with about 45 shares of the S&P. If you average it in each year, you wind up with about 24.31 shares. Assuming you hold onto it until now (current price $2496) you wind up with 112k vs 60.6k. To make the numbers even more contrasting, I should've taken the years 1985-2000.
If you run the numbers again from 2000-2014 (going through a recession and a greater recession), you wind up with 10.41 shares of the S&P buying 15k all-at-once (at the peak before the recession) vs approx. 12.03 shares. It seems timing's the most important thing. The more uncertain you are about the future, the better a strategy it is to average in, but even averaging in from 2000-2014 during two recessions only gave a 14% difference, but of course, the market is probably getting propped up, so it's value is higher than it should be, so the rules have changed.
@kaylbee, You are right "timing is the most important thing" but unfortunately the majority of people are very bad at this. As you said "If you run the numbers again from 2000-2014": if some average guy invests 10k in 2000 he would have probably gotten out of the market in 2003 when the price fell from $1500 to $800. If not then 2007 bear market would have definitely taken him out as the price fell from $1563 to $680. Dollar cost averaging is for an average guy, who like the majority of others end up being emotional. But if someone who can do his homework he is better with investing full amount at once at "right time".
kaylbee
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@Wave-Expert, Agreed. I think averaging works much better for the beginner investor as a means to separate emotion from trading and if you're beginning you won't have any sense of timing/strategy/experience. Following averaging-in would've definitely helped me lose a lot less money in my first attempts at investing.
Wave-Expert
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@kaylbee,thanks for reply :) Dollar cost averaging works with index funds because of diversification. Given that you invest $100 at the start of every-month no matter where the stock price of s&p500 is, you would have made money at the end without any kind of market experience. There are million of people who are smart but at end of their trading life in loss, they are in loss because of emotions and their reliability over charts but DCA allows someone to get over these problems.