Possible Pluses of Recurring Investments
Get Your Hedge On...
Though hedging strategies are often associated with short selling or the use of derivatives, hedging is technically defined as any action taken to limit losses. Even though short-selling, use of derivatives, or frequent selling may not be appropriate for the average retirement investor due to the cost and time associated with those strategies, the practice of dollar-cost averaging may be an accessible way to reduce the chances of entering the market at a peak before a downturn. The last market peak was in January 2022. Since then, stocks plunged more than 27% at their lowest. Though the overall market has recovered since its October lows, anyone who bought during the peak in January of last year would still be down more than 10% on their purchase. Buying at a peak is definitely an undesirable investment action, especially when a painful and prolonged downturn follows the peak.
Dollar-cost averaging may be a simple way to reduce the chances of buying at a peak. Though it can seem counterintuitive to continue purchasing stocks when they are making frequent new lows, as they did for much of 2022, buying during market downturns can be desirable opportunities for long-term investors. For example, instead of only buying at the January 2022 peak, if an investor would have also bought again during the lows seen in the last part of the year, they would have lowered their average share price from the level of the peak. The lower average share price would provide them with a higher return once stock prices recovered. Dollar-cost averaging simply means buying more frequently instead of less frequently.
Time In, Not Timing
Trying to time the market by guessing opportune times to buy is difficult to do for even the most seasoned, knowledgeable, and experienced professionals; and it is virtually impossible to do with sustained consistency. Investing on a recurring schedule, regardless of market conditions, can reduce the element of chance and guessing involved in market timing. Making frequent purchases in smaller amounts as opposed to less frequent purchases in larger amounts may reduce the probability of buying at peak prices. Regular purchases can help smooth out an investor’s average share price as compared to the fluctuating ranges of highs and lows of market gyrations. We recommend that the average retirement investor set a fixed schedule for making allocations to investment accounts. Sticking to the schedule, regardless of market conditions, may be beneficial for the long-term retirement investor.
We analyzed results from 21 hypothetical investors with various allocation schedules and compared their average share prices. Varying investment schedules of once per month, once per quarter, twice per year, and once per year were used. For schedules of less than once per month, different months were used for each hypothetical investor. All the hypothetical investors started investing in 2019, and invested the same amount per year. Outcomes showed that a schedule of once per quarter (four times per year) could have led to an average share price that was 2.2% higher than a schedule of once per month. A schedule of twice per year could have resulted in an average share price 3.5% higher than a once per month schedule. Buying just once per year could have led to an average share price 5.2% higher than buying every month.
Stick With It…
While hedging strategies may limit the potential for losses, they also reduce potential gains; and it is important to note that buying less frequently can result in average share prices that are lower than a more frequent schedule. However, buying more frequently appears to reduce the chances of having a higher average share price, which is why Aesop Advisor recommends the average retirement investor, if possible, make allocations at a minimum of quarterly (every three months).
June 7, 2023
Markets Demystified is published the first and third Wednesdays of each month, and explores how stock market investing can relate to personal finance.
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