DCA: Maybe the Most Important Investment Decision You Will Ever Make

May 13, 2009

So once again this week’s show topic was inspired by real life events. You would have to be living under a rock to not notice the gains we have been experiencing in the stock market over the past few weeks. But is it real?

Despite all of the upward movement, I am still very concerned about underlying fundamental problems such as:

  • Commercial real estate
  • A potential second wave of home foreclosures (for more on this, check out John Hussman’s weekly market commentary)
  • Credit Card defaults
  • What happens when the government stops doling out money? Can these financial institutions sustain themselves without the training wheels?

So therein lays the problem. When do you start buying into this whole ‘stock market’ thing? Is it smart to try and buy now before this thing really takes off? Should you wait to make sure we are really on the way up?

These are great questions, and I have personally been receiving them from both my young clients as well as my clients who are nearing retirement. So what is the answer?

Well it is really quite simple, and not only is it simple, it very well could turn out to be the most important investment decision you will ever make. The best time to buy is… now, and tomorrow, and yesterday!

To say it another way, dollar cost average into the market. Investopedia defines dollar cost averaging as:

A technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share  price. More shares are purchased when prices are low, and fewer shares are bought when prices are high.

I know, I know. It seems so simple. And it is, but with slightly more involvement. I will go ahead and be right up front with you, if you are retired and are in the decumulation stage of your financial life, DCA is not a pertinent topic for you. However, if you are still in the accumulation stage, and I do mean at any point of the accumulation stage, then dollar cost averaging is a good fit for you!

So I’m sure you are now asking, ‘Brian, how can a 51 year old and a 21 year old have the same investment strategy?’ The answer is that the strategy is the same, but the ingredients are different. Even though DCA will work for both younger and older individuals, the difference lies in your asset allocation. Being near to retirement, an individual should absolutely have a much more conservative asset allocation than that of a 21 year old. (If you are unsure about the right asset allocation for your specific situation, we will have a very useful tool available on our premium member section for you to use)

Let me describe it a little differently. If you think about your portfolio as one giant ‘pizza pie’, then each slice should represent a different stage of your life. One slice should be the right now slice (i.e. cash), one should be the 5-10 year slice (i.e. fixed income), and for those of you who can expect to live for 10-20 more years, you should absolutley have a growth slice.

As you listen to the show, I will go in depth into many of the advantages that DCA can have for you. Listen for some of these following guidelines to really make this a successful strategy:

  1. You must have a correct asset allocation (a 65 year old picking penny stocks probably won’t work)
  2. You must stick to the plan. Remember when the market is crashing and burning, that is when dollar cost averaging really shows its advantages.
  3. Make it automatic. Don’t count on yourself to write a check every month. Pick one day each month and have an automatic transaction take place. After a while, you won’t even miss that money that you thought you couldn’t live without.
  4. Don’t go overboard. Start out with a low-ball estimate. If you feel like you maybe could do $1,000 a month, back down to $800 and make sure you KNOW you can stick to the plan. Then, as cash builds up, you can make periodic catch-up purchases.

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