Outsmarting Yourself Dollar Cost Averaging Down
During the most recent correction which amounted to about a 10% drawdown of the Standards & Poor’s 500 index, Otto, mentioned he had “stopped making contributions to his retirement account until the “Stock Market” recovers”. “My account is going down faster than my deposits, for Pete’s sake!”, he says. Cecilia on the other hand is oblivious to her retirement account and her contributions continue. So, what happened?
I proceeded to develop a hypothetical* example to test the question.
Let’s say Otto stops making retirement plan contributions when the “Stock Market” drops from $50.00 to $47.50. And resumes making contributions when prices resume where he left off at $47.50. He would have missed the drop to $35.00. Yet, he would have been down about 28%.
As the “Stock Market” reaches $50.00, the price at which he started making deposits, his account balance is $6,158 for a compounded rate of return of 2.63%.
Cecilia by neglecting to look at her account, let’s her deposits continue and investments ride. As a result, her maximum draw down is only -17% to Otto’s -28%. And, her compounded rate of return is 14.77% versus Otto’s 2.6%.
How are these seemingly counter intuitive outcomes possible?
Simple: by continuing to purchase as prices decline, Cecilia accumulates 241 shares at an average price of $43.50 to Otto’s average share price of $49 accumulating only half as many shares, 123. As the “Stock Market” recovers from its dip, Cecilia’s portfolio grows much faster. Why? She purchased more shares at cheaper prices – bought low and bought twice as many.
Buy low and hold, sell later….
Our portfolios and strategies reflect over weighted positions in US and International Equities.
Carlos Dominguez, CFP® – Portfolio Manager
*Hopefully the reader will understand that the hypothetical and example discussed in this brief article is not intended to represent reality in any form but simply puts forth the idea that “Stock Markets” fluctuate and that by consistently having the faith to invest, especially when equities retreat, usually results in a reasonably good wealth accumulation strategy. The hypothetical does not reflect actual investment results and is not a guarantee of future results. Results may vary for each investor and over time.
Sources are being provided for information purposes only. Raymond James is not affiliated with and does not, authorize, or sponsor any of the listed sources. Raymond James is not responsible for the content of any source or the collection or use of information regarding any source’s users and/or members. Past performance may not be indicative of future results. The S&P 500 is an unmanaged index of 500 widely held stocks that is considered representative of the U.S. stock Market. Inclusion of these indexes is for illustrative purposes only. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary. Any opinions are those of Carlos Dominguez and not necessarily those of Raymond James. This material is being provided for information purposes only and is not a complete description, nor recommendation. The information has been obtained from sources considered reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Dividends are not guaranteed and must be authorized by the company’s board of directors. There is no guarantee that any statements, opinions or forecasts provided herein will prove to be correct. Dollar cost averaging involves continuous investment regardless of fluctuating price levels of such securities but does not assure a profit and does not protect against loss. Investors should consider their financial ability to continue purchases through periods of low price levels. There is no assurance that any investment strategy will be successful. Investing involves risk and investors may incur a profit or a loss.