With the markets getting banged up earlier this year, you have a LOT of opinions being thrown around on the best way to passively invest in the stock market.
Because of this “Dollar Cost Averaging” has been making its way around the internet again as the best thing since sliced bread…but does it actually work long term?
So in this article, I’m going to cover:
What is it?
Should you use Dollar Cost Averaging?
Does it make sense?
Is this a good strategy?
Or is Dollar Cost Averaging not so good…and just plain stupid?
So let’s dive into some examples to see if Dollar Cost Averaging is all it has been hyped up to be.
What Does Dollar Cost Averaging Mean?
The first time I remember hearing about it was in the ’90s where the market were basically just going straight up.
Around that time financial planners recommended it because, at that time, you could basically close your eyes and buy, and within a few months you would have made money.
They would suggest that at the same time every month you would purchase a particular stock or stocks, no matter what it or the rest of the market was doing.
Let’s take a look at and example using Apple (AAPL).
This morning I went back over the past 17 months, so from January 1st, 2019, and I looked at the price of Apple at the beginning of the month.
So the idea here is that you would invest $1,000 a month into AAPL shares.
Let’s go through a few months and see how it performs, starting with January 1, 2019.
At that time, AAPL was trading at $154.89/share. With my $1,000, I could have purchased 6 shares, costing me $929.34.
Onto to February, AAPL is now trading slightly higher at $166.96.
This time around you’re only able to purchase 5 shares with the price of the stock now higher.
If you would buy 6 shares, you would invest more than $1,000. The rules for Dollar Cost Averaging is that you have a maximum amount that you stay below.
So now you have bought 6 shares for $154, and 5 shares for $166. This means that you now have 11 shares and the average price is $160.
The idea here is that you keep doing this every month, and you see your average price changes.
If you continue to do this for 17 months, you would have accumulated a total of 69 shares.
And over these 17 months, you would have invested around $15,000 to be exact, $14,998.
So the idea here is that you invest a fixed amount every month.
Now let’s take a look at an Apple chart really quick here and see what has happened since January 1st, 2019.
Right here, I marked it in green.
As you can see, Apple has been consistently going up, until it was hit by the pandemic but has since recovered and is going nicely up.
So what does this mean for your 69 shares that you would have accumulated over the past 17 months?
Well, 69 shares, and the current price right now of Apple is $317.
This means the current value of your 69 shares is $21,934, which means that you would have made a profit of around $7,000.
If you express this in percent, it would be a gain of 46% over this past 17 months or 33% per year.
Not too bad.
So Does Dollar Cost Averaging Make Sense?
Based on this example, it seems that Dollar Cost Averaging is a pretty good idea where you are investing a fixed amount regardless of what the price is.
The main concept or idea here is really to make trading or investing as easy as possible for everybody by not worrying about the stock price.
But…is it really a good idea?
More Dollar Cost Averaging Examples
I chose two more stocks, that I’m sure you’ve heard of before and one somewhat special for me since I used to work for them: IBM
IBM is a household name, their stock in the Dow, so I think most would agree they’re a solid company worth investing in, right?
I can remember back in the day when everyone (including your barber) was telling you to invest in names like IBM and AT&T.
So these are the two stocks that I want to look at right now.
Example – IBM
On January 1st, 2019 IBM was trading at $112.01, so we could buy 8 shares and invest a total of $896.
If you were to look at the chart, you will see IBM’s price fluctuated between $112 to $134, and went all the way up to $140.
Now we’re following the exact same principle that we did with Apple where we’re buying shares for $1,000 always on the first of the month regardless of the price.
Therefore we are adjusting the number of shares. So after a year, we would have accumulated 120 shares with an average price of $132.
So after a year we would have invested $15,919 into IBM.
Now as of today, today is May 21st, 2020, the current price of IBM is $120. So let’s take a look at the charts before we come back to the results.
So we’re looking at IBM and we are doing the exact same strategy that we did with Apple.
We start on January 1st, 2019, and every month we are investing a fixed amount.
As you can see, IBM has not been going up as nicely as Apple.
This is exactly the problem, if you look now at the Dollar Cost Averaging, we see that over these past 17 months we would have actually lost $1,500.
That’s a loss of 10% over 17 months or 7% a year.
So what does this mean? Is Dollar Cost Averaging a good idea or not?
Before I answer that question, let’s take a look at one more example.
Example – AT&T
Over the years everyone has said, “Invest in AT&T. This is what grandma did,” right? Didn’t grandma invest in AT&T and hold the stock forever?
So I thought let’s use this as an example.
Now, since AT&T is trading at a much lower price, we can afford to buy more shares.
After the course of 17 months, we would have 405 shares, and we would have invested around $16,800.
Let’s take a look at a chart and see what AT&T did over the past year and a half.
Very similar to IBM, a little bit better, AT&T was going up until the pandemic hit.
As of today, May 21st, they still seem to be hurt.
So what does this mean for the Dollar Cost Averaging?
If we look at the current price of $29.64, the current value is almost $15,000.
We did invest almost $17,000 so we are sitting on a loss of $1,842. This is 11% down over 17 months, or 8% down over the past year.
Is Dollar Cost Averaging A Good Strategy?
What does all of this mean?
Dollar Cost Averaging is a concept that comes from the 90s and this is when the markets were just going up-up-up.
Right now we are coming out of the longest bull market in history. It has been steadily going for 11 years, so it should actually work like a charm.
The critical part, the absolute key for Dollar Cost Averaging to work is to pick a stock like Apple that is constantly going up.
And, hey, can you ever really be sure that you’re picking the right stock?
I personally think that Dollar Cost Averaging is kind of a stupid concept, even though it is super simple.
I believe if you put a little bit of effort into learning how to trade, that you can run circles around the market.
Because even if you look back at our example of Apple, we see that we made 33% per year.
The way I personally trade, I only spend maybe 15 minutes a day trading and my goal is to make at least 60%.
Recently, I traded an account and almost doubled it in two months.
Right now, I’m trading another account where I’m planning to make at least 10% per month.
With a little bit of effort, I believe that you can run circles around Dollar Cost Averaging.
I highly recommend that you learn more about how to trade and don’t fall for the simple kindergarten principle here that is Dollar Cost Averaging.
Anyhow, this is my take. Now you have some real-life examples and can decide whether this makes sense for you or not.