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Dollar Cost Averaging
The idea is insanely simple. You invest evenly over a period of time and allow compounding to work its magic. This method, usually used when purchasing shares in your mutual funds (IRA's and 401(k)'s) spreads the cost of those shares over periods of inevitable ups and downs.
One school of thought suggests that dollar cost averaging is in essence a reducer of risk. When you reduce risk, you have the chance to reduce returns. Investing in a lump sum can be better if you have timed the market in such a fashion that you have hit the fund's NAVor Net Asset Value at a yearly low.
Another school of thought suggests that by investing one half of what you would invest in lump sum, investing the remainder over of the rest over the last six months of the dollar cost averaging period. This is according to M A Milevsky of York University in Toronto would expose you to greater returns without increased risk.
But remember that the market moves in often quick upsides and dramatic downsides. Investing evenly over the year allows you to buy at both highs and lows. This method favors beginning investors but it is also the first tool towards disciplined investing. This is what leads to wealth. The numbers can be quite extraordinary and convincing.
For example
A $100 a month invested over 35 years would grow to a whopping$492,826 at an 11% return. Breaking that number down even further.
For 25 years you have put $100 dollars a month away. Some years have been better than others, but you have historically gained a measly 11% return, the industry average. You have put $30,000 away for your future and you balance is now worth $157,614.
Thirty years of consistent investing and the account that you have barely poured a year's wages into is now worth $281,450!
Five more years, thirty five years of disciplined investments and it's time to call it quits. You have put $42,000 away for this moment. Was it worth it? A balance of $492,829 says it all.
These figures can be multiplied by whatever factor you wish. Save $200 and double each years return. Save $300, and consider the possibilities.
And the argument for starting young with the dollar cost averaging method is unbelievable. Let's take another example using an entirely different set of numbers.
Early starters who begin at age 25 and invest at the rate of $2000 a year in a fund that returns a paltry 8% could stop investing after ten years and expect $214,295 at age 59! Continuing to invest for another 24 years however would net the youngster a nest egg amounting to $372,200.
Starting at 35 under the same conditions and you would have a retirement account totaling $157,000 plus. Still not bad on only $48,000 in cash out of pocket.
Haven't had enough numbers yet and think that you can reach a million bucks by 65 or so. Well at age 25, you would have to make a 401(k) contribution of $1860 a year with a return of 10%. If the account grows at a rate of 15%, that contribution of yours could be cut to $425 a year.
Start at thirty five, and the yearly contribution at 10% to reach a cool mil would have to be at least $4900, less if you employer matches your contribution.
The lesson here is not to delay. Time is truly on your side...and the younger you are, the better off you will be. Order your copy of Building Wealth in a Paycheck-to-Paycheck World by Paul Petillo. It is packed with safe, proven wealth-building strategies that cover all the major components of a balanced financial plan, including: |