Dollar-Cost Averaging Investment Strategy

Dollar-Cost Averaging Strategy Psychology
Dollar-Cost Averaging Strategy Psychology

On a recent walk with my neighbor and friend, we got into a discussion about financial markets. This is a common occurrence for us and this time we talked about the Dollar-Cost Averaging Strategy, a technique many people implement to build their retirement savings. After our conversation, he suggested I write my thoughts on DCA out.

The following is my outline of what Dollar-Cost Averaging is, my experiences with it,  and how it can be used to help people achieve their financial goals.

The Dollar-Cost Averaging Strategy is an investment portfolio management technique that was introduced to the general public when mutual funds were first created. It was meant to introduce and attract new investors to stock and bond markets, while making it easier for small and medium-sized investors to participate in a new money-making opportunity.

However, I have a different take on the DCA strategy.

Before diving into my experiences, let's define some terms.

According to Investopedia

Dollar-cost averaging is a simple technique that entails investing a fixed amount of money in the same fund or stock at regular intervals over a long period of time.

If you have a 401(k) retirement plan, you're already using this strategy.

Make no mistake, dollar-cost averaging is a strategy, and it's one that almost certainly will get results that are as good or better than aiming to buy low and sell high. As many experts will tell you, nobody can time the market.

This definition gives you only half the story and it may or may not work for you, depending on individual circumstances. This definition also excludes the potential problems that will almost certainly influence how much money you will save, earn, or lose on your investment. Further, it omits the fact that markets must have near-perfect conditions to produce any significant results from this method.

Problems and Omissions:

  1. A "contract to live forever".
  2. DCA strategy’s ability to produce income that allows you to work until you decide to retire, without being laid off or fired by your employer and without the possibility of losing your business, if you are self-employed.
  3. Ignores the possibility of one ever getting a serious illness or injury that would affect your employment or business.
  4. Possibility of dishonest or failing financial institutions (remember Bernie Madoff and Lehman Brothers?).
  5. Requires favorable stock market conditions.
  6. The likelihood of improper uses of Dollar-Cost Averaging.
  7. The method tries to predict the market while claiming to do otherwise.

In the rest of this article, I will describe the possible solutions we can implement to counteract these problems and then go into more detail on how to properly use Dollar-Cost Averaging.

Solutions:

  1. A “contract to live forever” - As we all know, you can’t take it with you. However, there are several solutions you can implement to ensure your family and loved ones are well taken care of.
    1. Purchase life insurance and enough of it. Approach life insurance only as it’s meant to be used and never as an investment. Remember that if unexpected death comes knocking, life insurance policies MUST PAY for funeral experiences, vehicles, and mortgage payments.
    2. Create a Trust Account with a reputable financial institution to prevent misappropriation of funds. Trust Accounts are not only for the rich and wealthy. Trusts are meant to establish rules on how the money will be invested and spent and can be used to make sure finances continue to grow in our absence and provide support for our families.
  2. Ability to produce income - Most people will at some point have to use their savings to support themselves during hard times. This can put a very significant dent into their investment plan or completely and permanently destroy it. There are several solutions that can be put in place to counteract that.
    1. Create a Cash Savings Account. You can put this cash into a trust, so no one can touch it, including the government. No bonds, no stocks, no mutual funds because those fluctuate with the market and, if you need funds when you’re at a loss,  you will lose money at a time when you are most vulnerable.
    2. Your goal should be to have enough to cover at least two to three years of living expenses at your current lifestyle. When your lifestyle expands, your cash savings must expand as well. Never decrease your savings, only use it when it is absolutely a must.
  3. Never get a serious illness or injury - To counteract this problem life insurance companies offer a wide variety of Long-Term Care and Disability insurance products that can be purchased through your employer or individually. Keep in mind to beware of insurance companies trying to sell you what you don’t need and will never use. Purchase insurance products only, no annuities or anything like that.

    ONLY WHEN THE FIRST THREE CONDITIONS ARE SATISFIED CAN ANY INVESTMENT BE CONSIDERED VIABLE AND PRODUCTIVE.

  4. Dishonest or failing financial institutions - To mitigate this risk, work only with large and reputable institutions with proven track records and those that are big enough to be bailed out by the government in case of another financial crisis like the one in 2008.

    NOW WE GET TO INVESTING AND MAKING OUR DREAMS COME TRUE.

  5. Dollar-Cost Averaging should really be called Dollar-Cost Averaging Down. The maximum effectiveness of the DCA strategy can only be achieved if applied during a major economic downturn when we have the opportunity to purchase high-value assets at a deep discount.
  6. Improper use of Dollar-Cost Averaging.
    1. The DCA strategy can only be used as a long-term strategy and must be stopped after reaching the allocated investment amount or when an economic recovery is well on its way, otherwise it becomes a different strategy altogether.
    2. DCA can NEVER be applied to individual company stock. It can only be applied to Mutual Funds or ETFs. When applied to an individual stock, it’s more speculation than investment.
    3. Investment into a DCA strategy is better applied in a deeply depressed market and should be timed to coincide with upside signals in reversal indicators.
    4. The total investment amount should be divided into several portions to be invested at different times. I personally divide my cash into ten (10) equal portions, one or two of which are usually kept in reserve. So, 10% of the total investment amount will be invested every time I get an upside reversal signal, and a total of 80% to 90% will be invested if an obvious economic recovery is on the way. This strategy must be supported by positive economic news.
    5. If a large sum of capital is not available for investment, a regular periodic investment into a CASH or MONEY MARKET FUND can help accumulate enough funds to be used, at proper times, for investment.
    6. Once an economic recovery is on its way and we are well into money, we have to be on the lookout for another major downturn to be able to liquidate our positions and go all cash until a time when we can start investing again. This strategy must be supported by negative economic news.
  7. Trying to predict the market. Do not try to predict market behavior. Instead, try to listen to it because it always tells us what the next move will be. All we need to do is go with the flow and ignore the noise that is created by special interests.  Most importantly, do not try to time the lowest or the highest point - you will never be able to do that. Normally we can accurately predict when economic sentiment is changing from positive to negative and negative to positive. Because these turns are usually supported by major news reporting agencies, it is very hard to miss.

A final word of wisdom: if I’ve learned anything from my 30-year career, it’s do not become a victim of someone else’s agenda. Do your own research and do not believe a word of what stockbrokers and various financial advisers tell you. Most of them either push their own or someone else’s agenda and act as agents that facilitate the transfer of wealth from you to the banks and super-wealthy. Do what they do and not what they tell you to do.

Have any questions about markets, investment, or financial health? Ask away and I’ll answer in the comments or in another article!

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