The stock market can be a scary or thrilling roller coaster depending on how you look at it. Heck, just in the last year, the stock market (e.g. the S&P 500) dropped 26% in three weeks’ time and then ended up over 16% for the entire year. That is a big swing and that can be stressful for many of us. Markets are unpredictable. However, if you make investing for your retirement in a 401(k) or IRA automatic with each paycheck, it can help you benefit from dollar-cost averaging and help you stay the course during volatile times.
How Does It Work?
In a 401(k), with each paycheck you are putting a percent of your salary towards the investments you selected. (If you don’t have access to a 401(k) or if you have extra money to invest, you could set up a bi-weekly auto-ACH from your bank account into an IRA or retail investing account). No matter what is happening with the markets, you are contributing a set amount on a regular, frequent basis. When markets drop, your money will buy more shares, and when markets rise, you are buying fewer shares – this is dollar-cost averaging. While there are no guarantees, over the long-term, dollar-cost averaging can help build more wealth. This example shows how it can work:
The Upside of Dollar Cost Averaging
|Period||Amount Contributed||Fund Share Price||Shares Purchased|
|1 (market high)||$500||$100||5|
|2 (market low)||$500||$50||10|
|3 (recovering market)||$500||$75||6.67|
|Value||$1,625.25||21.67 shares x $75|
By sticking with your investing plan in this hypothetical scenario, your account value is currently 8.35% better off even though the market has not come close to exceeding the previous high of $100 per share.
Some people try to time the market, but historically, many end up selling when markets drop in fear of “losing” money, and then buy back in when markets are doing better. This is the exact opposite of what you want to do as you end up selling at a low price and buying at a high price and achieving poor returns. By putting your long-term investing on autopilot with dollar-cost averaging you help avoid bad temptations to sell at a low, and you can help put yourself in position for a bigger nest egg too!