July 2024
Here are some key takeaways from their conversation:
- Patrice shares her first experience with dollar cost averaging through her 401(k), highlighting its discipline and long-term benefits despite market volatility.
- Dollar cost averaging (DCA) can help mitigate emotional stress when investing large sums. It can also offer potential tax benefits and loss offsetting through tax loss harvesting.
- Chris emphasizes DCA’s role in systematic and automatic investing, providing stability during market fluctuations.
- Studies indicate that lump sum investing may outperform dollar cost averaging two thirds of the time, although DCA still has its benefits.
Watch previous episodes here:
Ep. 94 Behind the Scenes: How Morton Manages Investment Portfolios
Ep. 93 Why Valuations Matter When Investing in Stocks
Hello, everyone, and thank you for joining us for another episode of THE FINANCIAL COMMUTE. I'm your host, Chris Galeski, joined by Wealth Advisor Patrice Bening. Patrice, thank you for joining us.
Thanks for having me Chris.
When it comes to investing, there's the emotional component, right in making decisions. And is it the right time to invest? Am I investing in the right things? Time will only tell. And looking back, you always have 2020 vision. but one of the keys to successful investing that many people point out is the use of dollar cost averaging.
Now, dollar cost averaging is buying into investments over the course of time. it's sequential amounts of money. So like when I contribute to my 401k every paycheck, a portion of my 400 and K gets withheld and goes and is invested inside my four and k. So in theory, I am dollar-cost averaging when it comes to saving for retirement.
But when somebody comes to us with a lump sum, that's when the emotions get a little bit more tied in and say, okay, how am I investing this? Is it the right thing? At what price? And so there's some research out there that talks a little bit more about dollar cost averaging and the benefits of it. And even Vanguard, you know, a couple of years ago coming out and saying, that dollar cost averaging might not necessarily work, although it's something that we definitely believe in.
So when you think about dollar cost averaging and it's buying into investments over a periodic time frame, what comes to mind for you?
I'd say right away is that personally, when I first started using dollar cost averaging is when I got the first job that offered me to participate in a 401k. It created a discipline around my investing style because it kind of was a set and forget, you know, I started with 3% and then changed it to five, ten, whatever it is.
As you know, I make more money. But just having that set in place, I didn't have to make a decision every month if I wanted to invest or not. Not just money, but in my personal future. Number two, it helped me avoid the volatility of the market. I actually started in banking in September 1999.
I think we all know what happened in 2000. So I think even having to ride through when the tech bubble burst, I really wasn't worried. I was, you know, obviously on my mind I was still young, but yeah, my portfolio was down, but I was contributing small amounts. And truth be told, I was buying now more shares of investments at a lower price.
And, you know, as those, you know, as the market corrected, I was able to benefit from that.
Yeah. When you're saving for retirement, dollar cost averaging really works. I mean, it helps you create a plan that systematizes... that's automatic. And you pick your investment strategy and then the dollar amount you want to invest and you just systematically follow through with that. But when people are approached with sort of a lump sum to then start investing, whether it's the sale of a business or the sale of a home or some windfall of money, a bonus that they were, they're able to receive.
Sometimes they're apprehensive about, you know, okay, where am I going to invest this? How much risk am I going to take on? Because they don't want to lose money and neither do we. And so dollar cost averaging I believe helps more with the emotional component of investing. There's some real big tax benefits to doing it as well.
Vanguard's research in this article, it says two thirds of the time looking backwards lump sum investing actually does outperform dollar cost averaging. And when I look at it, it's looking at the numbers, but not the emotional psyche that that that comes along with that.
I think people discount a lot how much our emotions come into play when it comes to investing. I tell my friends and professionals in my life, I say, investing is easy. You hire people that can follow models. So it's the emotions around your investing that are hard to manage because truth be told, we have FOMO.
We read the news. We talk to our friends, and then we decide to make decisions that will not be in our best interest. And a lot of times, like if we might be even the most experienced investors. But we are notoriously bad at timing the market. And I don't think anyone really can successfully time the market in the long term.
Yeah, studies have shown time and time again that the long term returns for bonds is call it 5 or 6%. The long term returns for stocks, call it 8 to 10. But the average investor only earns like a 2 to 3% rate of return. And it's not because they're investing. It's how they react emotionally to their investment strategy and how they context switch from time to time, from trying to get in and out.
Timing the markets is extremely difficult. In fact, nobody can do it. Otherwise they would technically be managing all of the money in the world. So when we're approached with this situation that helps clients invest, we choose dollar cost averaging here. When we're putting money to work in the stock market, maybe into gold or other assets that are designed for growth, like real estate.
But when it comes to investing in fixed income or more of those stable, investment return vehicles, we we don't dollar cost average, we put that money to work right away. So that way we can, get the money working harder for you. But I believe that that dollar cost averaging is more of a mental decision. How are you going to feel emotionally if you invest $100,000 today, and then all of a sudden it's worth 85 or $90,000 a few weeks from now, because a few years from now, it's likely to be, well, more than $100,000.
It's worthy to mention that for me, it turned me from being a short term investor into a long term investor. So honestly, if you truly kind of think of it that way and understand the power of compounding returns when my money's making money, that's a beautiful thing. So I think dollar cost averaging, in my opinion, works.
Just because I am not the expert to tell you if what's going to happen tomorrow is going to be the best decision for me to have for the entire pot of money that I have to allocate.
That's a good point. One of the other reasons why I really like dollar cost averaging, especially if it's with money outside of a 401k or an IRA, is because you're buying some investments at different points in time at different prices. And so those purchases are what's called a lot. So I own, you know, a number of shares of the S&P 500 at this price and then a lower price and a higher price.
And then as time goes on, we're able to look at the portfolio and say, hey, is there any opportunity to do something called tax loss harvesting? Now we're not in the business to lose people's money. but if all of your investments are winning and losing at the same time, you have to ask yourself, am I properly diversified and do I have the right investment strategy?
And so that's where tax loss harvesting can be a huge benefit. You sell something at a loss. You buy a similar investment to keep that exposure. And you can use that loss to offset future gains down the road. And so it's a way for you to save a lot in taxes. That's one pro as to why you would want to say I want a dollar cost average.
Not only will it help me mentally get this lump sum of money put to work, but also it gives me the opportunity to potentially minimize my tax bill down the road.
And I think, I think that actually provides a lot of peace of mind. A lot of us, probably we get hung up when we see our portfolio going down just a bit and they go, oh, I'm down 5000 unrealized loss, right. But there are opportunities within that because we love it when things go up. We don't love it when we have to pay taxes on the things that go up when we sell it.
Like people get so anchored and I'll just wait for that to get back to even before I sell it. Well, that's a missed opportunity because you can exchange it for something similar and still get that exposure. But also looking at it, if something went up a lot in value, they get anchored to, I don't want to sell that because I don't want to pay any taxes.
It's amazing how the psyche plays more of a role in some of the decisions people make than others, and that's why having having a good advisor, makes sense. When we were talking about this, you mentioned the fear of the emotional and psychological implications of dollar cost averaging. Why don't you touch on a couple of those?
Well, I think we can get very impulsive if we did not have something in place where we can be like, I, I've had it. I'm going to pull out of the market because I feel like everything's going, you know, down the drain. Honestly, if you really look to seeing, you know, what the power of having a small amount of money going into an account for whatever reasons, I dollar cost average to my 529 for my kids.
I dollar cost my regular brokerage account, and I do it inside my 401K. And then what I've noticed that over time, I'm just realizing how wonderful it is to just have this pot of money grow steadily and I'm not likely to have to make decisions because I don't react to the outside noise that can impact that.
So for you, it sort of reduces anxiety. It improves confidence a little bit, and it avoids that emotional decision making around timing, which are key components to long term success when it comes to investing. One other thing that when I think about dollar cost averaging, it's like market timing, as we mentioned earlier, is extremely difficult. And we go through seasons within the investment world where it makes sense that certain investments are going to do better than others, whether it's because of interest rates or economic growth.
But you could dollar cost average up or down within your portfolio, depending on how you're feeling about things. Let's say you've got 50% of your money invested in stocks, and you're feeling very uneasy about your financial situation or even what's going on in the economy. And volatility is scaring you because, like, let's be honest, this money means something to you.
It is providing you with a future lifestyle. It's helping you pay for a home or a car or kid's education. And we can't take away that fact that emotionally, those dollars that we see on a screen are tied to something that we want in our future. And so if you're feeling uneasy, you could work with your team to reduce the stock exposure by a little bit over a period of time and reduce it from 50% stocks down to 30 or 40% stocks.
So that way you feel a little bit more comfortable with the volatility, and vice versa. If you've got 30 or 40% in stocks and the markets go down, you can slowly dollar cost average by selling some bonds or some other investments to purchase more stocks when prices are lower. So that way you can benefit from the growth.
The key component of that is financial planning. So it comes down to the rate of return that you want to get. Talk to me a little bit about the importance of financial planning in me and the impact that it has on people.
I think making decisions in kind of in a, in a tunnel, like thinking I just, I want to have $3 million in one day, not knowing what that money really means to you without having the financial plan to back it up, to really understand kind of the components of your life and where you are today, and having kind of the the guide and the roadmap that a financial plan really gives you and the clarity around it.
So to your point is that if I want that money to check different boxes for me is how could I plan and how can I make that happen? And allocating and, you know, specifically to those buckets for my kids education, for my personal and for my vacations, maybe I want to spend $30,000 a year every year between now and age 85, taking care, taking my friends, my family on on lovely vacations.
I also want to make sure that maybe it's important to me that I don't want to put the burden to have my kids take care of me, and I want to have that kind of bucket allocated so that if something happens, they can just hire somebody for me, and then I know I'm taken care of and and then they don't have to worry about it.
Without a financial plan, I find that people are just making an emotional decision based on feeling and not the actual numbers in the context of what they need. But, you know, like we mentioned earlier, if stocks long term did 8 to 10% and bonds did four to 5 or 6, and then the average investor earns two and a half to three.
The main reason why that is is because people don't stick to a plan. So dollar cost averaging is just one of the key components to making sure that you have a plan for how you're investing. So if you're interested about learning more about investing or even wanting to talk to one of our advisors, please reach out to one of us or click the links below.
Disclosure: Information presented herein is for discussion and illustrative purposes only. The views and opinions expressed by the speakers are as of the date of the recording and are subject to change. These views are not intended as a recommendation to buy or sell any securities, and should not be relied on as financial, tax or legal advice. You should consult with your financial, legal, and tax professionals before implementing any transactions and/or strategies concerning your finances.
