“Be fearful when others are greedy and greedy when others are fearful” – Warren Buffett
It may seem like just yesterday but it’s been over 5 years since the huge market crash in September of 2008. Tons of jobs were lost and many people lost a significant portion of their life savings. Some countries nearly became insolvent (see: Greece, Portugal, Ireland, etc…). Crazy times.
You wouldn’t be able to tell that we just narrowly survived a huge failure of our financial system judging by how the market closed out 2013. On December 31st the market closed at record highs and the S&P500 cranked out a mind bending 31.8% year over year return to really end 2013 with a bang. That’s awesome and I sincerely hope you were invested in the market through Betterment or on your own to grab a piece of that action.
Not to be the harbinger of doom, but there is no way crazy returns like that are sustainable in the long term. In 2000 leading up to the popping of the tech bubble or in 2008 leading up to the housing bubble it seemed like everyone was getting rich in the stock market.
People were buying things they had no business buying and investing in things they didn’t even try to understand. Raw unfettered greed. Something that should scare even the riskiest of investors – if they were paying attention to the signs.
However, it seems the people paying attention to the signs were largely drowned out by the voices of blind optimism and as a result, very few people heard the warnings. Because, how couldn’t you make a cool million buying into Pets.com in 1999, right? Well, turns out you actually couldn’t because they declared bankruptcy in 2000.
How about flipping houses, a timeless wealth building strategy? We quickly learned in 2008 that we were flipping hot potatoes for years and that the real suckers were the ones who were still holding the potato when the music stopped.
Most of the greedy people leading up to those crashes lost big and if you were like Warren Buffet you would have been waiting on the side lines. See, after those crashes everyone became extremely fearful (and in many cases poor) so there were huge deals to be had. Super cheap houses some even in foreclosure, cheap stock valuations which were ripe for the picking, etc… you get the picture.
For the people who see the greed and wait until fear takes over, there is a lot of easy money to be made. Buy low, sell high, right? Or at least if you buy low you can sell whenever and still do just fine.
We’re at record highs and a lot of global indicators are starting to point to a potential slowdown or bubble on the distant horizon. What everyone wants to know is, when is that bubble going to bust? It could wind up bursting in 2017, or in 8 years from now – nobody really knows.
If you sat on the side lines waiting you could be missing some serious portfolio growth but if you went all in and poorly timed your investment you could wind up buying at the peak and making it very difficult for you to grow your investments competitively.
Truth is, most of us are not able to time the markets perfectly. We are not all interested in following the latest in Greek bond prices or the shadow banking system in China. If you’re interested, that’s great but most people have better things to do like brew craft beer.
If that’s the case, all you need to know about is the power of Dollar Cost Averaging. It’s something we’re big fans of over here and something that is an automated feature found in Betterment. Simply put, Dollar Cost Averaging is the act of buying an investment in regular intervals with a consistent amount of money for a set period of time.
Say you buy 3 shares of a stock for $300, the average cost per share there is $100. Now, if you bought those same three shares at a bad time, you may wind up paying $600 or twice the price per share at $200.
However, if you buy in smaller increments over a set period of time you will average or Dollar Cost Average the price you pay per share and thus reduce your overall cost. This can be seen in a scenario where you start at the bottom of the market:
- Stock Price #1: $100
- Stock Price #2: $150
- Stock Price #3: $200
- Average Price Per Share: $150
Or if you start at the peak of the market:
- Stock Price #1: $200
- Stock Price #2: $150
- Stock Price #3: $100
- Average Price Per Share: $150
These are very simplistic examples but as you see, by averaging your investment purchase prices over time you remove the importance of “timing” the market and average out any individual poorly timed purchases with many more purchases at average or even cheap prices. This can be an extremely effective strategy for new investors or investors that are terribly afraid of buying high thus never actually entering the market.
It is important to note that Dollar Cost Averaging as a term specifically applies to investing a fixed lump sum of money. At Listen Money Matters we lean more towards continuous automated investing with no strictly defined sum to invest. We know that over the course of time, the market averages a 7% yearly return. If we consider purchasing at consistent intervals with no defined end we will wind up mirroring the market achieving a roughly 7% yearly return with almost no effort.
This effect can be achieved by investing as little as $100 monthly or even $1,000 monthly like we are doing in The Betterment Experiment. The point is, as long as you start investing at some point with an amount that you are comfortable with on a consistent base that you stick to, you can’t lose. Really the only way you can lose is if you don’t participate.
So, when you remove the majority of the risk, invest with an amount you are comfortable with and can automate the process so it takes zero time to execute, why would you not invest? You go to work every day to earn money for your family, why shouldn’t your money?
If you want to be stepped through the process of investing with Betterment, check out the first article in The Betterment Experiment. If you want to see how well we are doing with our automation, check out our December update.
What do you think, is investing small amounts of money on a consistent basis sound like something you could do? Are you already finding success with this strategy? Think this strategy sucks? Share your thoughts with us in the comments!
Featured Image Photo Credit: “Greed” by liz west on Flickr