In January 2022, financial advisor Andrew Fincher was working with a couple who wanted to invest the six-figure proceeds from selling their parents' home. They were concerned that the market could plummet after the purchases.
Fincher, of VLP Financial Advisors in Vienna, Virginia, recommended dollar-cost averaging. Rather than investing the entire amount at once, he planned to invest a portion of his real estate earnings periodically over the next six months.
It worked. on the other hand,
S&P500
It started 2022 at a record high, but quickly plummeted as the Federal Reserve raised interest rates to curb inflation. The couple didn't feel the pain they would have if they had invested all at once.
“They were reassured that there was a strategy to invest their money that took into account their feelings about the situation,” Fincher said.
The ideal of investing is to buy low and sell high, but even Wall Street experts can't always do that. Instead, financial advisors tend to recommend dollar-cost averaging, saying it makes sense, especially in a frothy market like now where nothing is cheap.
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The market tends to go up about three times every four years. This means that if you invest a lump sum at the beginning of the year, you will earn more profit over a longer period of time than if you did not invest at all.
Rachel Elson, a financial advisor at Perigon Wealth Management in San Francisco who often works with younger clients, said there are two problems. The first is that you never know what the market will do in any given year. Second, people tend to have emotional attachments to money, and it's painful to see new investments disappear in a market crash.
“If you put a lot of money in an investment account and the next week the market drops 10%, how likely are you to want to invest in the future?” Elson says. “You just confirmed all your concerns.”
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Dollar-cost averaging eliminates anxiety. If you're contributing to an employer-sponsored retirement account like a 401(k), you're likely already practicing dollar-cost averaging because you're investing your money at a steady pace each paycheck. There is a gender. However, you can also use this strategy in your personal retirement or tax brokerage accounts through automatic transfers or setting regular calendar reminders.
“That way you don't get too mentally cornered,” Elson says. “This is a smart habit, especially for those just starting out.”
While dollar-cost averaging is a go-to strategy for many investors during every market cycle, advisors say it makes the most sense to invest over time when prices are high. You can take advantage of further appreciation in the future to smooth out your returns, but you also don't risk a large drop after investing the lump sum.
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When investors read headlines about the stock market hitting new highs, as they have in recent weeks, it can paralyze their analysis, said Marianela Collado, a financial advisor at Tobias Financial Advisors. says. She recommends dollar-cost averaging to many of her clients and her own strategy.
As a result, investors may want to wait until higher prices and volatility increase. But “finding the best time to invest is not really possible,” says Corrado. “Dollar-cost averaging allows you to filter out all the noise and stay disciplined and focused.”
As a result, they enter the market at different price points. This may mean that money buys fewer shares on certain days, while on other days it buys more shares.
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Any investment strategy has risks. Dollar-cost averaging is no exception.
Vanguard researchers calculated the equity of an initial investment of $100,000 using historical stock and bond performance and found that lump-sum investments tended to outperform dollar-cost averaging after one year. . However, the researchers also found that for some risk-averse investors, dollar-cost averaging is better because it “reduces the risk of drawdowns or abandoning investment plans altogether for fear of large losses.” He also acknowledged that this could be an approach.
Additionally, using dollar-cost averaging can increase your profits even in tough market conditions. Raymond James researchers looked at the performance of the S&P 500 over a 40-year period and found that investors who invested in the market in bulk at the market's peak posted an average annual return of 8.3% over a 10-year period; found that investors who started investing in Although it peaked, his average annualized return over 10 years was 10.4% using dollar-cost averaging over 7 months.
If you use strict dollar-cost averaging, you'll miss out on the huge profits that can be made by investing a lump sum at market bottoms. However, especially for inexperienced investors who want to buy at current high prices, dollar-cost averaging can provide peace of mind and confidence to continue investing in the future, potentially yielding positive long-term results. there is.
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