Gas prices are spiraling upward, inflation is higher than it’s been since the 1980s, and both the stock and bond markets are significantly in negative territory since the beginning of the year. Russia doesn’t seem to be lightening up on whatever quest they are on in Ukraine, and the Federal Reserve has been backed into a corner and is being forced to raise interest rates to slow our already slowing economy to curb inflation. It seems like a perfect storm and that the U.S. is staring down the barrel of an inevitable recession.
Warren Buffet, 91-year-old investment guru and leader of Berkshire Hathaway, says “Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.” What I believe he is speaking to is the practice of putting money to work when things seem to be at a good value. Not all of us have the educational experience and time to research corporate balance sheets and strategic management plans like Buffet and his team; but I want to share one way that common investors like you and me can make the market volatility work in our favor.
The strategy many investors use and many savers are already doing without realizing it is called Dollar Cost Averaging. Dollar Cost Averaging (DCA) money into the market is the strategy of making systematic purchases over a specific time period. In theory, during volatile times some of your purchases cost more, but some may also cost less. The benefits of putting money to work over a specific time period in equal increments are many – one being that it helps remove emotion from an investment strategy. If an investor decides to take $10,000 from their bank and instructs their financial firm to put $1,000 to work on the first of the month over the next ten months, it can help to smooth out returns when the market is volatile, therefore preventing an investor from being overly emotional during market downturns. Over the long term, this type of strategy could very well work to the investor’s favor, putting money to work systematically while the market is down, potentially allowing them to buy more shares of their investment at a lower cost than if they had put all the money to work at one time.
Many people implement Dollar Cost Averaging without realizing it. A systematic payroll deduction going into your 401k is, in essence, DCA. If you consistently put away $200 per paycheck, you have likely bought shares when the market was rising, but you very well could have been adding to that same position when the market was at a lower price point, allowing you to pick up more shares than before. DCA is in no way a failsafe for not losing money, and can also work against the investor. In a sustained bull market moving rapidly higher, a systematic purchase into a strategy could lead to you only buying shares at a higher value. So to be fair and balanced, this type of strategy is better utilized only when the market is in a period of lower prices often caused by a slowing economy or poor economic data. The hope of a DCA strategy is that systematic, equal purchases of market-related funds will smooth out returns in a volatile or downward moving market.
If you have money sitting in the bank earning very little interest, the 8.3% inflation rate (reported in June) is slowly eating away at your spending power. It may be a good time to talk to your financial advisor about getting that money working in a more growth-oriented fashion. Dollar Cost Averaging into the markets over a period of time may be a strategy to consider.
We hope you all had a fantastic Independence Day celebration and didn’t have to burn much gasoline to get where you were going. God Bless America! And God Bless the readers of My City Magazine.