The Beauty of Dollar Cost Averaging

One of the things we take for granted in America is how wide open the path to investing is. In many countries in Europe there is no equivalent to E-Trade or Robinhood. There are also no television shows in which a balding man throws bulls and bears around a studio, dispensing market advice to give the impression that if you listen to him, you too can beat the market.

Needless to say, traders live their whole life on their apparent ability to time the market (and are rarely audited on how accurate their claims are) and some academics have made it part of their research to prove that market timing is nearly an impossibility. Both sides agree that even if you accept market timing as a possibility, doing it for a sustained period of time is an impossibility.

Whatever you believe, the problem is that by the time you’ve “heard something on the street” it’s probably too late to do anything useful with it. If you’ve heard it way before the street heard about it, you might be committing a criminal offense (though you may end up becoming friends with Snoop Dogg as a result). But don’t take my word for it. Schwab did an article some time ago comparing investment styles and one of the profiles they created was “Peter Perfect” who had Ray Dalio-esque vision and did really well. But there’s no credible reason to believe you could be Peter Perfect, so the next two profiles might be of more interest to you, Ashley Action and Matthew Monthly.

Their performance in the experiment was almost equal, and while I appreciate the rubric for Ashley (she invests all her money on the first trading day of the year), I’m here to advocate for Matthew (he takes the same amount that Ashley does, but invests it over 12 equal installments). Matthew is a dollar-cost averaging guy.

Dollar-cost Averaging

Quick review: as noted above, dollar-cost averaging is investing the same amount of money at a targeted investment at regular intervals over a certain period of time…regardless of price. This can lower average cost per share and mitigate the impact of volatility on a portfolio. It also removes the pressure to find the ultimate moment to buy at the best prices.

While this is a strategy pitched to beginning investors, it’s one that seasoned ones use too. Not only does it avoid Ashley’s one-time all-in (which could be poorly timed), but it also habituates people to investing automatically. Investing, like anything worthwhile in your life, is built from solid habits.

Use Data, Not TV Shows

Everyone’s portfolio mix is going to look different based on goals and current age, but the broad ratio to keep in mind is cash savings vs. long-term investments.

Once you’re clear on your allocations, set it and forget it. Want to know the power of consistent investing? If you invest $200 per month in an ETF returns 7% per year, in 50 years, you’ll have over $1.1 million dollars. 

Part of you might be saying…no, no this is too easy, why doesn’t everyone do it?

Firstly, maybe not everyone is doing it, but a lot more people are doing it these days, in part because of what John Bogle and Vanguard did to popularize index fund investing. It’s no longer a niche idea, and automatic investing has become popularized by companies like Betterment and Wealthfront. 

But more importantly, the numbers don’t lie. You don’t have to understand why it works or why others aren’t choosing dollar-cost averaging as a strategy. You just have to be willing to try it for yourself and see the returns stack up.