A Quiet Fortune column: Serious slides and dollar cost averaging
A Quiet Fortune
Good grief, what’s a new investor to think if even the experts can’t predict things?
“Dow Blows Past New Milestone” announces The Wall Street Journal on January 18, 2018. Less than two weeks later, ”Stocks Slide After Long Surge” was the headline hovering above a dramatic downward graph with this text below: “Some investors and analysts believe the slide could mark the start of a market adjustment. Others say strong corporate earnings and economic growth world-wide will continue to support stocks.”
If you’re new to the idea of investing in stocks I can’t blame you for feeling uncertain. Is the stock market good or bad? Should I invest now or am I too late? Is it plummeting? Is it worth the worry?
I’d like to give you a valid reason to remain calm if you’re confused about whether to invest in the stock market.
First, be aware that there is always media hype going on, whether the market is surging higher or moving downward. Seems like every news source we turn to covers daily gains and losses as if they were the only numbers to pay attention to. Yes, those statistics are important: The market did rise significantly during most of the last 10 years. But we are always cautioned that there will come corrections.
However, corrections are not automatically a terrible thing. When the market climbs to record highs, more and more investors usually pile in, driving prices — but not necessarily companies’ real values — up rapidly. A market adjustment can keep values and prices (the PE, or price/earnings ratio) more in line.
We’ve had our share of bubbles when certain stocks rise astronomically then eventually crash, and the ensuing result hurts. Someone who invests a large amount of money on one particular day when prices are escalating might be one of the people who curses a month later if there’s a downturn, adjustment, correction or crash.
But there’s a big plus in store for the small investor who steadily puts a portion of his or her salary into the market instead of dumping a huge amount in on one specific day. It’s called Dollar Cost Averaging. Here’s an example:
Let’s say you can invest $200 monthly in the stock market. You set this up for automatic deductions from your paycheck. (This leaves emotions and second-guessing out of the picture.)
Now we’ll say that this month the market is doing fine. The mutual fund you’re investing in costs $50 per share, so at that price you’ll get about four shares of the fund. Sounds OK.
Next month the market has risen considerably and shares are now valued at $60. Great, right? Yes, but this month you’ll receive only 3-1/3 shares instead of four. They’re worth more, so that’s good, you say.
Now comes a stunning tumble. Shares of your mutual fund fall to $30 each. But if you stay calm and collected and don’t sell, this month you’ll get 6-2/3 shares for your $200.
By the end of three months you’ll own almost 14 shares instead of the 12 you would have had if the market had stayed even. Their cost would average out to less than $43 instead of $50 or more per share. When this happens repeatedly through the years, the increased number of shares you own can make a real difference to your eventual wealth.
Of course, the fund must be a solid one and time is essential for the market to recover. Younger people can put dollar cost averaging to good use, but investors close to retirement must be more cautious; They should be sure they won’t need that money any time soon. If you might need it you should get good advice about “how long you might have to hang on to recover those losses,” as Jason Zweig cautions in his Feb. 10-11, 2018, Wall Street Journal column, ‘The Intelligent Investor.”
The takeaway from this: Understanding dollar cost averaging can help us become levelheaded investors. It does help me stay calmer during slides.
Terrie Drake is the author of the book “A Quiet Fortune” and a retired teacher and librarian. She and her husband have lived in Glenwood Springs since 1974. She is not a financial adviser; consult a competent professional for your personal financial solutions. She can be reached at firstname.lastname@example.org