Hi everyone, welcome to another wealthy and wise Wednesday, hope you are doing good whether you are listening to the podcast or the video, hello. And today I wanted to talk about this concept that is very prevalent in financial planning world and the concept is called dollar cost averaging and essentially I think it gets misused quite often because dollar cost averaging is different than what most people think.
[00:00:59] if you are investing in let’s just 401K and each month, you invest in it, that is often referred to as the dollar cost averaging. When in reality it is just investing regularly and it is because you don’t have a lump sum or you are not using a lump sum and you are just taking a portion of your income each week and you are investing into a mutual fund or your 401K or whatever that is. Well, that is technically not dollar cost averaging, even though many financial advisers called it that. Again it is just investing regularly kind of have the same effects, sometimes you buy high, sometimes you buy low and it is supposed to average out your purchases.
[00:01:48] But true dollar cost averaging is only applicable when you have a lumps sum. Let’s just a $100,000 to invest and you want to get it in the stock market but you are wondering oh should I put in the entire sum now or should I put in a little bit here and there and that is truly dollar cost averaging when you decide to spread that out. Let just say you know over a year period of time and let me just give you an example and the real question then becomes does this dollar cost averaging actually works? Because if it does, we want to take advantage of it and if it doesn’t we want to avoid it. And again we are talking about having a lump sum, you are maybe you are just retiring and you have now got all these money sitting in the 401K, you want to roll it over into a portfolio or some sort and the question is, do you just dump it all in, maybe you sold the house, you have got this equity that you want to invest now, I mean there is a lot of reasons why you might have a lump sum.
[00:03:02] could be just because your business and the income you bring in and you have built up this capital and now you are trying to decide do I jump in all at once or do I spread this thing. Let’s look at a couple examples, let’s just take Apple since it is a very popular company, let’s just take Apple stock. Let’s say you have a $120,000 and you are trying to determine if you should just you know dump in a $120,000 into Apple right away or take $10,000 a month for the next 12 months and use the strategy of dollar cost averaging. Okay, well first you have got to understand that, that is really not investing in a nutshell, that is more speculation.
[00:03:51] only time investing is investing is when you really understand what you are investing in and why you are investing and you are buying at a lower price than its values. Always kind of referring to the Warren Buffet strategy and that is true value investing but we are going to throw that out the door right now and we are just going to assume you just like Apple stock, which is a good start but you don’t know if it is valued high and low and so you are more of a speculator, you just want a $120,000 worth of Apple and the question is do you dump it all in now or put it $10,000 a month.
[00:04:34] so let’s look at starting out January 2nd, 2008 and what happened in 2008, we all know it is one of the worst years on record where everything just dropped down. So had you drop in a $120,000, January 2nd, 2008 well you would have lost about 56% of your money if you would have just look at it the next year and that is simply because you probably didn’t look at value and price and you just jumped in. Now, had he used Dollar Cost Averaging in that situation, so January second, you put in 10000 February second, 10,000, March 2nd 10,000 and so forth. Then you would have only lost only 39%.
[00:05:26] so dropping it all in January 2nd, 2008, you lose 56%-dollar cost averaging, you are only losing 39% so it made sense obviously to use dollar cost averaging in that scenario. That is when the market is pretty much losing all through the years. So let’s that same experiments if you will, let’s just go one year or later where the market has already taken in a hefty dive, prices are down, this by the way is when you should be buying when prices are below value and so it is January 7th, 2009 and now you have got that same choice, am I going a dollar cost average or am I going to dump it in. So here we could have more than double the portfolio value by investing in all at once, while dollar cost averaging returns two times less.
[00:06:25] So dollar cost averaging basically does not work very well when we are in an uptrend, when market is moving on while you are buying less and less each month because the market keeps on escalating. We would have been much better off dropping it in all at once. So let’s just simulate and investing a $120,000 into SNP500 index, the symbol for this is SPY and let’s just say we are going to take again that same 10000 dollars over the next few months and we want to determine whether it is better to invest it all at once or to spread that out every month at $10,000 a month. Well, in the past 27 years, if you took every 12 months’ investment in there, the investment within the SNP500 had you just invest it all at once, you return would have been about 8.77%. Using dollar cost averaging over those same period, your return would have neem 4.77 percent.
[00:07:36] almost half the return using dollar cost averaging than you would have gotten putting it in a lump sum. Now, there are two reasons for that; one is just simply because a dollar cost averaging in upmarket, you are getting less for your dollars but the other is the drawdown or the low return in money-market or cash. So in other words, if you had a $120,000 you can put that in some sort of money market check in or saving account and that has such a low return that it ends up you know some of that money is getting zero return for the whole year while you are waiting for it to get into the market. Maybe not zero, maybe half a point or who knows, maybe lockout and get a point but anyway the idea is you have got a lot of money sitting there in cash and money market is doing nothing for you. So in the past 27 years, dollar cost averaging really hasn’t worked, yet it is one of those things that is preached from the puppet so to speak every day from traditional financial advisers and again I have given a little slack because most of the people that I am working with are just looking to invest on a regular basis because they don’t have a lump sum but for the most part those who come in [00:09:05] advisor with a lump sum, dollar cost averaging has proven over the last 27 years to really be a failed concept.
[00:09:16] so what we have got to do if we do want a dollar cost averaging, more importantly and this is so much more important to dollar cost averaging, this is just buying when the price is lower than the value and substantially lower. You know Benjamin Grant, Warren Buffet, Charlie [00:09:32] they like values or prices when they are below about 50% of its value, so as you analyze your stock, if you go back to Apple and we look at its cash flow and when we look at its revenue, where it could be in the next 10 years, we will say okay, Apple have a fair value of 100 dollars a share. Well, what Warren Buffet and Benjamin Grant and all these people preach is that you should probably buy that when the price is about 50% lower than its value. So it is 50 dollars this year, what happens when the market becomes irrational and they do, becoming irrational actually within a 10-year period a time. [00:10:17] have a year or two in there where they are irrational and it gives you an opportunity to get in when the prices are below value, that is the most important thing.
[00:10:27] because otherwise we are just speculating. If we don’t really understand the value of a company and where it could be in 5 or 10, 20 years from now, then we are just speculating, we are just saying, oh I like this phone and I like Apple so I am going to just invest into it. Rather than really analyzing and understanding where a good price point will be. That is the most important thing, if we can determine price against value, that is a good opportunity and that’s with anything whether you want to buy real estate, a business, gold, Apple or anything in between, those things have to be evaluated so that you are getting [00:11:11] and the prices below the value.
[00:11:14] the second thing is if we are going to sit in cash or capital, if we are going to put it in a storage facility, we would like to do it in a place that give us a better return than a money market or cash or check in or savings or even a bond because all those things are taxable and once great storage place where you can store this money and get an above average return is in the high cash value life insurance because you not only have a tax free growth on that money but you have access to it whenever a market drop and you can take advantage of it. So to really combat this thing, you want to store your money in a facility where you get a better than average return, some tax benefits, access to it, and then when we have an opportunities come along whether it is an individual stock, whether it is real estate, gold, cryptos whatever you love and it has an opportunity there because the price is way below its value then you can get involved in that way.
[00:12:33] but you really need to do your research, you really need to understand what your opportunity is, what you are looking for, you are looking to buy a business or some sort of an investment and then taking advantage of dips once you have even got in there, then you have another terminology called averaging down. If I love Apple at a 100 and I can buy it a 50 and I buy that 50 but then it subsequently drop to 30, I have really got to love it, that is even better and I averaged down and I can buy on dips and if it goes to 10 but I still see the fundamentals and the companies still moving forward, then I am even happier now I can even average it down further and so if I have done my homework and I really know what is going on inside that company or that business, then I want to take an advantage when those market even drop or dip further.
[00:13:28] so rather than just pre-determined intervals, I am going to put $10,000 in on the second of the month, every month because you are speculating then you know build a strategy that is going to let you store your capital in a nice safe location, you can be very patient and keep building it up, I mean you might go 3, 4, 5 years before you even access that money for opportunities and that is okay. Main thing is, it is getting above rate of return. It is in tax free and liquid environment and you can take advantage. Dollar cost averaging in a nutshell really isn’t working, it is a hyped strategy by most financial advisers and it is used incorrectly or I should say the terminology is used incorrectly. Investing regularly is not dollar cost averaging and so when we have a lump sum, we are better off storing that capital until we have opportunity coming along, where price is below value.
[00:14:36] how many times can I say that? Well that is the last time I am going to say because we are out of time, we are ending this podcast and video right now, so I hope this was good information for ya, or wasn’t too confusing, especially if you are listening in but if you are any questions, always shoot them to firstname.lastname@example.org. I will answer them just as quick as I can and also take advantage of the subscription and make sure you are always stay tuned to the podcast and video. Anytime you want a strategy session reach out as well and we will take it from there. That is it for this week, great to be with you and thanks for tuning in and have a great week and we will talk to you next week. Take care.