Dollar Cost Averaging: How to beat a “flat market”

January 5, 2012 — Leave a comment

January 5, 2012

The S&P 500 has a negative return between February 2000 and today when dividends are excluded. That means if you put $30,000 in the stock market in 2000 it would be worth less today! Why the heck would I want to endure the risk of investing in the stock market for 11 years for no return on my money?!?!

I’m sure you’ve seen many similar news stories asking the same obvious question. It’s been an extremely rough decade for investors who’ve ridden the more-painful-than-usual roller coaster ride. So why should you gamble your hard earned money in the stock market??

Well, the sad part is nothing is more proven to provide a larger return for your money over a long period of time than investing in the stock market. Gold has been on a nice run, but its worthiness has an investment is questioned due to it’s volatility and long term track record (more on this in another article). Even CDs and money market accounts are hardly earning anything right now; five years ago you could find high-yield savings accounts with 5% returns; today those returns are down to .7%!

There’s still hope, I promise.

When you look at the stock market over the last 12 years, it’s been anything but flat. In fact, the S&P 500 went all of the way down to 735 in February 2009 and all of the way up to 1,549 in October 2007! Today it stands at 1,277. How do you take advantages of the big swings (especially on the down side)?

The answer: Dollar Cost Averaging

Dollar cost averaging (DCA) is the practice of investing regular amounts of money on a fixed timetable. Basically, it’s conceding the belief in your abilities to time the market and instead letting the calendar pick your purchase dates.

I dollar cost average by making regular contributions into my 401K from my paycheck. This is the most common way people DCA because it’s so easy to do through your company.

Running the numbers

As mentioned before, if you put $30,000 in the stock market on February 2000, you would have less today. However, what happens if instead you put $200 a month into the stock market starting in February 2000?

No way the $200/month could even come close to the $30,000 investment, right? Well, prepare to be amazed (Ok, maybe not amazed, but at least act surprised!).

For this analysis, I’ll use the S&P 500 index fund (SPY) to track your $200/monthly investment. Index funds are meant to mimic the movement of the market so it will match the fluctuations of the S&P 500 like a mirror. Your $200 contribution will automatically enter the market the first of the month. Here we go:

Total contribution period: 143 months (just under 12 years)

Monthly contribution: $200

Total contribution amount: $28,600

Value after 12 years: $35,317

There you have it… by dollar cost averaging, you would have had an overall return of 24.5% on your money. Granted, it’s still pretty low when annualized, but at least it’s better than losing money.

The benefits of DCA are really transparent when you look at the monthly data. The minimum price of SPY was $68.53 in September 2002; so your DCA purchase got you 2.9 shares of SPY while today it’s at $127.5 (1.56 shares).

This is somewhat reassuring to me because it proves that even during one of the worst stock market periods in history, money can still be made if you invest for the long term. If the investing purchase decisions were left up to me, I probably wouldn’t have bought in Sept 2002 because I guarantee the “world was coming to an end” according to the media.

Instead, I’ll let my DCA do the work for me and not worry about timing the market. If you get in a good routine of doing this now, it will pay off handsomely when we finally begin our next bull run.

Do you invest regularly? If you need to learn how to start investing, start here.

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