Discipline With Dollar Cost Averaging

On 03/16/2011, in Investment Strategies, by Jordan Wilson

I like disciplined investing.

For me that means following a well-planned strategy, with minimal emotion.

Unfortunately, many investors are not disciplined. 

Some investors do not understand how to build a structured portfolio. They lack the investment expertise and experience to create a long-term strategy.

Others do have some experience, but circumstances – personal, general economic, market – cause them to deviate from the planned path.

Emotion often plays a large role in negating self-control and investing discipline.

Individuals get caught up in the euphoria of bull markets,. This leads to purchasing at market peaks or getting trapped in investment bubbles. Or afraid of falling prices, they sell into bear markets or entirely avoid investing when prices are falling.

Fortunately, DCA helps achieve the discipline lacking naturally in the majority of investors.

A Quick DCA Recap

You should take a long-term investing perspective with DCA. Each week/month/quarter/etc. you invest a fixed dollar amount into “solid” investments.

Depending on your investment knowledge, “solid” can mean a variety of things. For those starting out, or for those who lack the time or desire to develop expertise, I suggest low-cost, well-diversified, mutual funds or exchange traded funds as excellent choices.

Because you invest a fixed dollar amount each period, the quantity of the asset acquired fluctuates based on changes in the asset price. If the investment appreciates, you buy proportionately less shares each period. If the investment depreciates, you end up with relatively more each purchase.

Assuming the long-term price trend is positive, you will ride out the short-term hiccups and be buying during down cycles at sale prices.

DCA Promotes Well-Planned Investing

We covered this in our look at consistency. A consistent and steady investing pattern should promote discipline.

You define a constant investment pattern and adhere to it over time. When times are a little tight, you stick with your plan. That is discipline.

If your personal circumstances change significantly and permanently, you can alter your patterns. But do not adjust in haste, especially when thinking about reducing your contributions. Stay disciplined.

Unless financial difficulties are extremely severe, I suggest you try and not shift your investment contributions down. Whether that is with less money or fewer periods. Instead, try and cut other discretionary expenses (e.g., Starbucks) and maintain your investing pattern.

And as you experience permanent increases in income, always try to bump your investing flow. If you get a temporary increase, such as a bonus, invest the windfall without increasing your periodic contributions.

The more (and earlier) that you invest, the greater the long-term compound returns. So endure a little financial pain now. It will pay off significantly over time.

DCA Minimizes Emotional Investing

A disciplined investing style should eliminate emotions from the equation.

Should, but in reality for most investors, probably not 100% of the time.

Emotions are emotions, after all. Very hard to control.

To the extent you can eliminate emotions from clouding your investment decisions, the better the probability of long-term financial success.

If you identify and invest in solid assets, you will have less emotional issues during price fluctuations. You expect that the long-term price trend will increase, so you believe that any down turns will be temporary.

And while individual assets, such as Enron or Nortel, may fall forever, a well-diversified portfolio should protect you from the nonsystematic risk associated with any one asset.

That should help you sleep at night.

For those made of sterner mettle, you might actually be happy during market downturns when following DCA.

In believing that the long-term price trend is positive, you see temporary price dips as buying assets at a sales price.

For example, you invest $500 monthly into a no-load index mutual fund. In January, with a net asset value (NAV) of $20, you are able to acquire 25 units. In February, the NAV increases to $25 and your $500 will only get you 20 units. But in March, a natural disaster in Japan causes your fund to drop unexpectedly to $16.67. Assuming this is just a temporary blip, you are now able to purchase 30 units at this  special sale price.

Not too bad if you are taking a long-term investment perspective with a diversified portfolio.

In short, DCA promotes investment discipline.

One that attempts to ensure a consistent investment pattern. That also assists in minimizing emotional interference during periods of market fluctuations.

1 Response » to “Discipline With Dollar Cost Averaging”

  1. I definately agree with your 1st comment.

    Tiffany Bonfiglio

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