Investing consistently is a key building block of wealth building, but many people don’t understand why it is so powerful. Well, today we’re going to explain it for you! And once you understand it, you’ll be even more motivated to keep your investing consistent.
First, make sure you have your emergency fund in place, and focus on becoming debt-free. Because hey, knocking out a 10% interest rate is similar to gaining 10% on an investment – so do this first. Then take a look at your household budget to see how much monthly cash you can allocate toward investing.
Whatever this amount is, lock it in, put it on the budget, and invest that exact amount every single month. Do this regardless of what the market is doing or what the talking heads on TV are saying. Be like Nike and Just Do It.
Here’s how much do YOU need to invest, from any age, to become a millionaire. Even if you don’t have the exact amount you need monthly right now, get started. Start where you can right now and increase it over time. That’s absolutely fine and a great way to start your millionaire plan!
Again, set an amount and stick with it. Invest when the market is going strong, and when the market is tanking. Invest consistently.
By the way, this principle has a name:
Dollar-Cost Averaging
Dollar-cost averaging, or DCA, is the practice of investing a fixed dollar amount on consistent intervals (typically this is monthly) in spite of what is going on with the stock market.
While this is “simple”, it isn’t quite easy to implement in practice.
The reason is that investing, like most financial matters, is just as much about emotion and behavior as it is about math. Sending a check to your investment company when the market is in a free-fall is emotionally challenging. Our emotions tell us to hold back and wait until the “right time” to make the investment. Of course, study after study has confirmed that most people, including investment advisors, are horrible at timing the market and this costs investors millions of dollars in missed gains.
Helping with these behavioral challenges is another reason we like Betterment. You can set an amount, and desired timing, and Betterment will handle the transfers for you automatically. No need to think about it or worry about what the market might be doing.
The trouble with trying to “time the market”
I talk to many people who think it just isn’t the right time to make an investment deposit right now – for any one of dozens of reasons. Oil prices, the value of the US dollar, the economy in China, wage levels, etc, etc. Since drama draws viewers, the people reporting the news are likely to focus on whichever unpredictable variable is most popular at the moment.
So what many people end up doing is holding on to the cash that should be invested (or worse-case they spend it instead of holding it) and they wait for the perfect opportunity to invest.
The problem is: when is that perfect opportunity?
If the market is in a downtrend right now, do you wait for it to start going back up again? If so, how much? Maybe wait for it to rise 5% before putting in your money, but who is to say it won’t trend back down again even further than the recent rise? Or what if it doesn’t trend back down, but since you waited you missed out on a 5% gain in this example.
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The point is there is no perfect time
Have you heard of Warren Buffett? I’m guessing you have. He made a $1 million dollar bet that a buy-and-hold strategy in an S&P 500 index fund would beat the returns on five actively managed funds (aka market timed and industry-shifted investments) over a ten year period. Eight years into the bet Buffett’s S&P fund had about three times the returns of the actively managed funds.
Market timing isn’t working out very well even for these top-notch investment managers who do this every day for a living. So then why do so many people think they can do better? Maybe because they don’t understand the magic math of consistent investing.
Consistent investing – dollar cost average investing – is exactly how slow and steady got me to a half-million in my retirement account in my early 40s. Together with my wife’s retirement account, we’ve passed the million-dollar mark. This really works.
The Magic
Let’s look at a fictional stock – we’ll call it MYM – as a way to illustrate the power and magic of dollar-cost average investing. In this example, we have $500 per month budgeted for investing and we will follow the DCA principles and invest that amount on the 15th of each month, regardless of what the stock price is doing.
So here is how the investing looks over a fictional six month period:
| Month | Amount Invested | MYM Share Price | Shares Purchased |
|---|---|---|---|
| Month 1 | $500 | $75 | 6.67 |
| Month 2 | $500 | $100 | 5 |
| Month 3 | $500 | $50 | 10 |
| Month 4 | $500 | $80 | 6.25 |
| Month 5 | $500 | $125 | 4 |
| Month 6 | $500 | $100 | 5 |
| Total Invested | Average Price | Total Shares | |
| $3,000 | $88.33 | 36.93 |
This is fairly straight-forward but I’ll make sure one point is clear: Since we are investing the exact same dollar amount each month, the number of shares purchased changes each month due to the stock price changes. What that means is when the price is lower, you purchase more shares and when the price is higher, you purchase fewer shares.
So when the stock is discounted, you buy more; when it is priced at a premium you buy less – all without any thought or work required of the investor. It just happens automatically.
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That is pretty powerful when you think about it. Here is something else to think about: your average purchase price is lower than the stock average price.
Yeah, really. You can see that the average stock price over the three months is $88.33 above, but since you bought more at a discount and fewer shares at a premium, your personal average cost per share is only $81.23 ($3,000 invested into 36.93 shares).
That sounds to me a lot like “beating the market”, but without even trying.
Side note: If you had invested $500/month into the S&P 500 index over the past 30 years, you’d have about half a million today.
Market fluctuations – volatility – is your DCA friend
When you are still in the wealth-building phase of life, and following the dollar-cost averaging principle, then market fluctuations are a very good thing!
Market fluctuations – aka “volatility” – are a normal part of market cycles. Stocks go up, and they go down, then up, then down. In fact, there tends to be a market correction (a drop of at least 10%) every few years – even though the long-term average is around a positive 10% annual gain. These fluctuations are normal and an expected part of investing, and when you practice DCA investing, that’s good for you!
If the market happens to be down 10%, 20%, or even more – that means you are buying your stocks at discount fire-sale prices!
Far too many people see this and panic then stop their investing, but that is absolutely the wrong way to look at this. You need to look at it as part of your overall long-term strategy and understand that price fluctuations, and even corrections and “bear markets” (declines of 20% or more) are normal and okay.
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The amount doesn’t matter as much as just doing it
Of course the more you can invest, the faster you will be able to grow your wealth through investing. But understand that something is better than nothing. Even if you can only afford $50/month this year – do it, then work to increase the amount over time.
Time is your friend when investing. It is a marathon and not a sprint. So the sooner you start investing and the longer your time horizon, the more growth potential your investment account will have.
If you are looking for an easy way to get started with investing you might want to consider a “robo-advisor.” This is a low-cost investing service that makes it easy and affordable to build a diversified portfolio. The most popular option and the one we recommend is Betterment.
In Closing
Hopefully, this helped clarify the power of consistent monthly investing for you. If you haven’t already, it’s time to develop a personal investment plan that uses dollar-cost averaging to maximize your returns; and to avoid the many challenges with trying to time the market.
Do you use dollar-cost averaging already? If not, do you have any questions about it? Let us know in the comments below.
This post originally appeared here: https://maximizeyourmoney.com/investing/everyone-should-know-this-the-magic-math-behind-consistent-investing/