Seeking a strategy for investing during a down market? A plan of systematic, or regular, investing, known as dollar cost averaging, can help you take advantage of changing market conditions and avoid the futile approach of trying to time the market.
Regular investing can help you cope with the human tendency of hesitating to invest in a declining market, when stock prices may actually be more reasonable.
With dollar cost averaging, an investor invests the same amount at regular intervals — for example, $500 each month — regardless of whether stock prices rise or fall. Using this strategy, investors can buy more shares at lower prices and fewer shares at higher prices.
A program of regular investing can help take the emotion out of investing when markets turn particularly volatile, because your long-term strategy doesn’t change. There is no need to make a drastic adjustment. In fact, taking money out of the market or ceasing to invest during declines might result in selling low or missing the chance to add to a portfolio when prices are down.
To illustrate the potential benefits of dollar cost averaging, take a look at the table below. In this hypothetical example, an investor bought shares of a mutual fund at three regular intervals, paying $15, $10 and $20 per share. When the price fell to $10 per share, the investor bought more shares. When it rose to $20 per share, the investor bought fewer shares.
Total invested: $1,500
Number of shares purchased: 108.33
Average price at which the shares traded: $15
Average cost: $13.85 ($1,500/108.33)
The key is that the average cost of the shares was $13.85 per share, whereas the average price on the market was $15 per share. This means that the investor was able to avoid paying an average of an additional $1.15 per share simply by investing regularly and using the power of dollar cost averaging.
Of course, to take advantage of a systematic plan, investors must be willing to stick to the strategy during bad markets. Regular investing does not ensure a profit or protect against loss, and investors should consider their willingness to keep investing when share prices are declining.
Now that we’ve discussed the potential benefits of dollar cost averaging, let’s look at how a systematic investment plan might have worked for an investor during the past two decades. For example, consider a hypothetical investment of $500 at the end of every month in the S&P 500 Index, with all dividends reinvested, over the 20 years ending on December 31, 2023.
During the 20 years of this hypothetical investment, there were periods of market declines with various highs and lows. However, at the end of those 20 years, the individual would have invested a total of $120,000 but built up an account balance of $428,991.
If you and your financial professional decide that an automatic investment plan makes sense, you can get one started online.
S&P 500 Index is a market capitalization-weighted index based on the results of approximately 500 widely held common stocks. This index is unmanaged, and its results include reinvested dividends and/or distributions but do not reflect the effect of sales charges, commissions, account fees, expenses or U.S. federal income taxes.