Dollar Cost Averaging

    

Changes in the monetary value of your retirement plan's mutual funds look a lot like a steep roller-coaster when tracked on a short-term (weekly or monthly) basis. Contrary to public opinion, price fluctuations, sometimes of great magnitude, are not exceptions in the stock market… they are the norm. Many people are turned off by all the gut-wrenching fluctuations. Because of this, some will choose to stay away from stocks all together. One investing technique provides a fresh perspective during market upheavals. The technique is “dollar cost averaging” (DCA); it provides an innovative way for investors to focus on what they gain, whether the money-price of stocks are rising or falling.   

By using the dollar cost averaging approach, you can treat the market as always in your favor. That is, you are always either gaining money or gaining assets... irrespective of what the market is doing.   If the price of your mutual fund shares (whether they are inside of or outside of a retirement plan) are rising, you are gaining monetary value; and if the plan share price is falling, then, using the DCA technique, you gain more total investment assets when prices are low over the months and years that you are purchasing.  The DCA technique is being used by millions of Americans every day, even if they don't know it.  Most participants in an employer-sponsored Qualified Retirement Plan (401k, 403b, Thrift Savings Plan, etc.) designate a fixed dollar amount (or percentage of income) to be contributed each pay period to buy assets.   

Imagine that Sally Saver chooses to send 5 percent of her monthly salary, $200, to purchase 401k plan assets.  Each month the Plan Administrator uses the $200 to buy a fluctuating number of plan shares. That is, as the dollar amount going to the 401k is fixed, the number of shares that are purchased must fluctuate (unless the price of the assets remains exactly the same over time… which they don't).

We can take a case study and examine the DCA method of investing.  On May 30, 1997, Amazon.com's share price was $1.50. By December 10, 1999, the price had risen to an astronomical $106.68, per share. The price rocketed by approximately 100 times (100X) in less than three years. Under less intoxicating and quasi-normal circumstances, investors might look for a stock's price to just double (2X) in a span of six years. Amazon, however, was on a very, very steep rollercoaster; and by November 10, 2001 (23 months after its astronomical high) the price had plummeted back to earth and settled at just $7.05 per share. Under our scenario, imagine that among your Plan's choices was Amazon stock. Beginning in May 1997, using $200 per month, you would simply receive “X” amount of shares each month. If the price were $1.50, then you would get about 133.33 shares in that month; when the share price rocketed to $100 per share, then you would only get 2 shares in that month. When the price drops rapidly, you get the opportunity to greatly increase the number of shares (assets) that you own. And when the price goes up, the dollar value of holdings goes up. Either way, you are either flush with green, or flush with assets.

How can millions of Americans unwittingly be using the DCA approach, but not be taking full advantage of what it offers?  Why do people get depressed when their share prices plummet inside their retirement accounts?  It's all perspective. Far, far too many people who are investing in a qualified retirement plan look at the shares only in terms of money; by thinking in terms of the DCA technique, people should be thinking in terms of either money (when it is actually time to sell) or assets.    

If you are worried about a single company going bankrupt, consider that most retirement plans offer, among other choices, the opportunity to invest in mutual funds that track a highly-diversified, very broad cross-section of the stock market. Shares in this type of fund represent ownership in America's largest corporations (by revenue). Among so many others, this means that you are taking a fractional ownership position in such titans as (in no particular order) General Electric, IBM, Exxon Mobil, Coca Cola, Bank of America, Boeing, Wal-mart, Dow Chemical, Dell, Pepsi, and 490 other mega-corporations. One company may go bankrupt, but the asset values in the broad mutual fund, in the long run, are greatly buttressed by the entire 500 companies. Bottom line: if you need money to buy groceries next week, then you should rightly be concerned about money only. However, if you are investing for a multi-decade future retirement (say you are only 30 or 35 now)… then you should strongly consider whether a little more money is better now, or whether a lot more ownership in these corporations' future profits (purchased on the cheap) is the better deal.  If you have a time horizon that is more than ten years out, the answer should be academic.  

Warren Buffett, singularly the world's greatest investor (a poll was taken among professionals in late 1999), has summarized the idea of buying assets in one of his famous similes.  He considers stock shares as hamburgers.  Buffett contends that if you love hamburgers, then you should reasonably want to buy hamburgers on the cheap. Temporarily depressed prices, therefore, are your friend; it's all a matter of perspective. Wall Street pushes its perspective (one that calls for hand-wringing every time the market falls) in the daily financial media; people are inundated with the Wall Street Way.  However, the opposing perspective, the one employed by Warren Buffett since the time he only had $100 to invest, has produced tens of billions of dollars in profit.   The choice remains yours: view stock values as seen by Wall Street, or view them as seen by Warren Buffett.  The viewpoints are distinctly different.