Don’t Try to Time the Market; Dollar-Cost Average Instead. Here’s Why

So says Andy Kiersz (businessinsider.com) in edited excerpts from his original article* entitled The Simple Stock Market Strategy For People Who Are Afraid Of The Stock Market.

 [The following is presented by Lorimer Wilson, editor of www.FinancialArticleSummariesToday.com and www.munKNEE.com and may have been edited ([ ]), abridged (…) and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. This paragraph must be included in any article re-posting to avoid copyright infringement.]

Kiersz goes on to say in further edited excerpts:

There’s A Correct Way To Buy Stocks As The Market Is Crashing

The stock market is great for investors who have the benefit of long-term investing horizons. It’s also better suited for investors who aren’t concerned about perfectly timing market tops and bottoms. Having said that, taking a longer-term view is good for investors worried that they may be buying at the top of the market.

A strategy called dollar-cost averaging can help reduce risks surrounding an asset falling in price. The concept is straightforward: You invest a fixed amount of money in an asset once every fixed period of time. If the asset’s price drops, you will be getting more shares of the asset for the same amount of money, and so if and when the price recovers, you will have spent less per share, on average, than if you had bought the shares at their peak pre-fall price. Dollar-cost averaging isn’t about losing money as the stock market falls. It’s about buying increasing numbers of shares at cheaper prices, which means bigger returns during the rally.

How Dollar-Cost Averaging Worked Brilliantly During The Last Crash

To see this in action we had our hypothetical investor put $50 into an S&P 500 index fund every month starting at the last peak in October 2007, arguably the worst time to buy as it was just before the beginning of the great recession. Here is what happened to the S&P 500 starting at that peak:

Business Insider/ Andy Kiersz

The index dropped more or less steadily until the worst moments of the financial crisis in the fall of 2008, causing the full-on crash, and only began to turn around in March 2009.

Based on changes in the value of the S&P 500 index, we calculated our investor’s price return, less the $50 monthly cost:

Business Insider/ Andy Kiersz

The value of our investor’s portfolio as of January 2014 was $5,631.87. If he, or she, instead, had taken $50 each month and held it as cash, the investor would have just $3,800 so the price return on this investment, even though the investor started at the last peak just before the market started to go downhill, was $1,831.87 which is a respectable 48% return…or about a 7.6% annual rate of return.

To get another perspective on this, here is the percent gain or loss, compared to taking $50 each month and holding it as cash:

Business Insider/ Andy Kiersz

Things start out looking pretty dire, as the economy fell into its deep recession through mid-2009, with the S&P 500 reaching a minimum in March of that year. At the low point, in March 2009, our investor would have been down about 34% compared to just holding cash.

Because humans are often overly risk-averse, our hypothetical investor might have been tempted to abandon his or her investment plans during the bad months. That is, he or she might look at this chart and panic about the drop:

Business Insider/ Andy Kiersz

but if our investor stuck with the plan and kept putting $50 in every month — even through dark times — once the market bouncesd back he or she would have ended up doing quite well:

Business Insider/ Andy Kiersz

Here’s Why You Never Hear About This

Unfortunately, dollar-cost averaging isn’t sexy. It’s much sexier to sell at the top and buy at the bottom. Obviously, your returns would be much higher if you win the stock market lottery by perfectly timing the tops and bottoms of the market. However, almost everyone who tries to do this will find themselves losing money, and lots of it.

If you are investing for the long haul, and can hang on through watching your portfolio’s value drop temporarily in bad times, starting to invest in stocks, even near a peak, may not be as terrifying as it looks. The market has always bounced back sooner or later, so if you can hold on until later, don’t panic.

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