Market Beat: Dollar cost averaging offers more bang for your buck
Dollar cost averaging is a common investment strategy that many people use to build positions in stocks or mutual funds over time. Employees who contribute to their retirement plan on a regular basis use dollar cost averaging.
If you add a set dollar amount regularly to your retirement plan funds that is a form of dollar cost averaging.
Say you put $500 per month into your retirement plan at work, those dollars are invested on a regular basis into the market and the result is that you can build a substantial portfolio over time.
The stock market goes through cycles of volatility on a regular basis. The market spends about 85% of time rising with low volatility and approximately 15% of the time falling with higher volatility. Investors who are putting a set amount into the market on a regular basis are taking advantage of the market volatility because they are buying consistently and will be buying more shares when the market goes through its inevitable bear markets and corrections.
If you work for an employer who has an employer sponsored retirement plan and matches some of your contributions, you should set up your budget so you can maximize the matching contribution from your employer. If you’re not saving enough to get your employer’s maximum contribution, you’re leaving free money on the table. Say for example that your employer will match 100% of your contribution up to 3% of your salary and you earn $50,000 per year. That means if you contribute $1,500 per year, you employer will add $1,500 and your contributions will automatically double before they are even invested.
Dividend reinvestment is another form of dollar cost averaging. Dividend paying stocks and mutual funds allow for the dividends to automatically be reinvested into more shares. Over time dividend reinvestment can also help build your portfolio.
The ETF that represents the S&P 500, the SPY, currently pays a dividend at a rate of 1.82% per year. If you were to use that fund in your retirement plan you could dollar cost average from your contributions, your employer’s contributions and the dividend reinvestment.
Younger people should invest in stocks to build retirement then move funds into bonds gradually as they approach retirement. Income from bond funds can also reinvested into the fund to build the position before you need to start taking the income for your retirement.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.