31 – Cultivate with Dollar Cost Averaging

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Episode Overview:

We’re back on the road reviewing Ken’s Cultivation Roadmap. This time, Ken takes the roadmap metaphor a step further discussing dollar cost averaging and gas prices. If you were to take a vow to drive cross-country and never pay over a certain amount for gas, you just might not ever reach your destination! Gas prices are out of your control and if you let it completely dictate your actions, you’ll have a tumultuous journey, the same can be said about your investment. That being said, people don’t have lump sums to invest, thus dollar cost averaging might be our only option. Listen as Ken explains the discipline of dollar cost averaging and how you should approach investments so you’re not stuck roadside calling AAA.

Transcriptions are auto-generated, please excuse grammar/spelling!

Happy day to you. This is Ken Kaufman and I’m thrilled you’re here for episode number 31, “Cultivate with dollar cost averaging”. This is all part of the series that I’m doing on this roadmap to cultivating your assets and to introduce this topic today of dollar cost averaging I have a story, an analogy to share with you. Let’s imagine that you want to drive across the entire United States starting in Los Angeles and finishing in New York City. And the last order of business once you’ve gotten everything prepared and you’ve got everything packed for your trip all ready to go you go to the gas station and you say, “Okay. I am going to buy a quarter tank of fuel.” And you memorize that price that you paid per gallon and then you say, “I am going to…as I’m driving I’m not gonna commit to ever buy a full tank of gas. That price I paid is the highest price I’m going to pay and every quarter tank I’ve gotta buy at that price or cheaper or I will just have to wait and my trip will have to be on hold until I can buy cheaper gas.”

Okay. So in this analogy or this story certainly we’re a little over preoccupied with the fuel prices may be going up a few cents or down a few cents. At the end of the day it’s not gonna make that big of a difference. Yeah, it’ll make a little bit of overall difference if you end up paying 5% or 10% more in fuel than you originally paid as you’re going across the country. However, the effectiveness of what you’re trying to accomplish gets missed in that instead of maybe driving across the country and it taking four or five days it could take you months or years if those prices never return to your original purchase price. So as you go along with say the first gas station you find as you’re running out of that first quarter tank, you see that the price is the same. You think, “Oh, great.” Well, you’re in a very similar geography and it’s probably the same day and fuel prices don’t tend to fluctuate at least day to day or during the middle of a day I should say. But day to day they certainly can and they certainly can fluctuate with different geographies and there’s all these, you know, factors that come into making the prices of fuel go up and down from day to day in different geographies.

And so maybe I get lucky the first time and maybe lucky the second time that I’m again putting another quarter tank in as I run out of that second or third quarter tank and I’m finding that the prices are, you know, the same or they’re down a little bit but all of a sudden I get into a more rural area and prices are higher and I make this commitment. I’m gonna travel this country at this fuel price or less and I’ve gotta wait and wait and wait until who knows how long.

Now I realize this is a little bit of a silly analogy. Nobody would…well, I shouldn’t say that. Maybe somebody out there would do this and they’ve got the time and the bandwidth to be able to hang out in these places for long periods of time or maybe go haggle with the gas station owner and try to get the fuel for cheaper or at least, you know, the original price when leaving Los Angeles or one of the most recent prices if you’ve made it a decent way across the country. But the interesting challenge of this is that you assume that somehow you have control over the prices of gasoline or that you know when they’re gonna go up and when they’re gonna go down and you’re keeping your fingers crossed. Maybe you don’t know but you’re keeping your fingers crossed that this is all gonna work out and you’re making decisions that can be probably detrimental to your trip based on something that’s completely out of your control.

Now what does it have to do with dollar cost averaging? Let’s jump over for a second and talk about that. Dollar cost averaging is when you put money into an investment in a size increment that’s usually about the same over some interval of…period of time. A great example would be if you’re participating in your employer’s 401(k) plan and you’re having money deferred out of your paycheck every week or twice a week or twice a month or once a month, whatever your pay cycle is, that money is going in your 401(k) plan and that’s dollar cost averaging where your money is going in and it’s purchasing the shares of whatever you’re investing in your 401(k). And whether the market’s going up or down, it doesn’t stop the money from being deferred from your check and being invested in your behalf by those trustees. And if the market goes down well, you love that because you’re buying more shares. If the market’s gone up and…or your investment, I’m sorry, has gone up then that price is now higher and you’re gonna be buying fewer shares.

And all of that being said, nobody knows what the market’s gonna do in the short term. Nobody knows up, down, spikes and then especially depending on what you’re invested in in that 401(k) and where your money’s being put and invested.

So the analogy of driving across the country and trying to control something that’s out of your control but then ultimately hurting yourself is…well, that could be a negative thing. All of a sudden, what was a four or five day trip is now weeks, months, who knows how long.

So when we apply this to investing, it’s the same way. There’s quite a bit of research out there that says if you have…if you come into a lump sum of money. Let’s say you get a really nice bonus at work or there’s a death and an inheritance comes your way and it’s a larger sum of money than, you know, you’d normally know what to do with and, you know, you wanna put it away and save it and invest it for the future.

So in that type of a scenario the challenge with it is you might think to yourself, “Well, I’m not sure. I hear that the stock market’s gonna go down. It’s too low and the stock market needs to go down.” And when I’m telling myself that I think…or I’m sorry. The stock market’s too high and it’s gonna come down, it’s gonna crash. So if that’s really a true story that I’m telling myself then I would think, “Well, I don’t wanna invest that money now. I’m gonna hold it out and I’m going to put it in the market when it comes down.” The challenge is what if the market never comes down? what if where it’s at today in your investment price, what if where it’s at today is the cheapest it will ever be and you’re gonna miss out on that opportunity? You just don’t know. And the research shows that generally speaking people who hold money back for dollar…and dollar cost average their way in…you know, let’s say you inherit or you have a windfall of $10,000 and you think, “Okay, I wanna invest it but I’m just gonna do $500 a month or $1,000 a month and…or I’m just gonna hold it out completely and wait until the market gets to where I want it to.”

And again not knowing if the market or your investment’s gonna get down there, you’re gonna potentially miss out on significant opportunities. Now you could also save yourself some hassle and some pain of seeing, you know, this big lump sum go down but the research shows that about two thirds of the time doing the lump sum investment ends up better for you than dollar cost averaging your way in where…and again, dollar cost averaging your way in means you would break it up and say, “I’m gonna do a $1,000 a month or $500 a month or, you know, a $100 a week.” Come up with whatever set of intervals you want and dollar amounts.

But the point is that dollar cost averaging generally speaking does not get the best return. Lump sum investing gets the best return over time. And again, this is based on all the research and what the academicians have determined. But there are those chances that you could try to time the market and actually benefit from it. Most of the time you won’t and you’ll end up in a worse situation.

So the question then lends itself well, why would anybody dollar cost average and why would I encourage it? Well, here’s the reason why. Because most of us don’t have lump sums of money to invest. Most of us would have to save up that money and if we’re saving it up in say a bank account or a CD or something what we consider very conservative and capital preserving and not growth oriented we’re likely missing out on opportunities of growth in the market and we’d be buying at higher prices some time down the road if we’re dollar cost averaging. The time when it is perfect to dollar cost average is when you have a little bit extra every month and you wanna save and you’re having money come out of your paycheck into a 401(k). There’s a great discipline in automating your investment so that you…they’re happening automatically for you, you don’t have to think about it. They come right out of the bank account. They go right into your investment account whether that’s a 401(k) or you’ve got an account at Vanguard, IRAs, taxable accounts, whatever that situation is. Dollar cost averaging is a powerful discipline and it’s what all of us need access to because we don’t have all the money that we want to invest for the future or all of our medium and long term goals. We don’t have it all today. We’re peeling it off through our prioritization with the waterfall. We’re peeling some of that income off and deferring it in to these longer term savings vehicles and investing it so that it can grow for the future.

So the reason why dollar cost averaging is something that is a critical part of cultivating assets is because it helps you develop great discipline, automate it so that it keeps working for you and then you just…you don’t have to worry about it and you don’t even actually have to watch the market or worry about is this quarter tank gonna last until I can find somewhere at least as cheap as the last pit place to buy gas. There’s none of that worry, none of that concern and also just not worrying about am I gonna miss the…miss a downturn or an upturn in the market that I should’ve benefited from. At the end of the day, if you end up paying a few cents more or a few cents less to drive all the way across the country, it actually does not dramatically change the outcome of the cost. And it generally works that way with investing as well. You’re not gonna miss out on some opportunity.

Now it could be that you invest all your money and then the stock market goes down 20% the next day or your specific investment does. That can happen. It’s pretty rare. A drop that drastic happens…I can’t remember the study I saw. It’s like every 5 to 10 or 15 years. They’ve got these increments of how common is a 5% drop and a 10% and a 20%. Anyways, it’s pretty rare that that happens. It could. But if you have a long term game plan, even if it did, the market’s gonna come back. It’s much more likely that you’re gonna miss out on opportunity by keeping your money out of investments than if you put it in. And if you go all in and then dollar cost average the money that you’re putting in the market, that you’re pulling out of your income based on your waterfall and how you’ve prioritized each one of those pools in your waterfall.

So that’s it. This is how we dollar cost average with…or we cultivate our assets through dollar cost averaging. And to be clear, avoiding lump sum investments and avoiding lump sum growth because we’re afraid or we think we’re gonna try to time the market. That is the time when we are not…when we are ineffectively cultivating through dollar cost averaging. We dollar cost average when we’re peeling money out of our income every paycheck or every week or every month or a quarter. Whatever that timing interval is for you and you’re putting it away and you’re investing it. Perhaps the only real downside over the long term from my perspective is that if you truly are dollar cost averaging into what you’re investing in, the stated returns on that ETF or that mutual fund or the stock or whatever it is that you’re putting your money in, whatever that vehicle’s stated return is is not going to be your return. Because you’re buying at higher and lower prices through the year and you didn’t start with that lump sum investment at the beginning of the year and then it would grow exactly like the stated return say that it should have or gone down for the year.

So that’s about the only disadvantage of using dollar cost averaging is generally speaking you’re not going to get the stated returns and generally speaking they’re not gonna be as good, the returns that you get because you’re missing out on growth as you’re dollar cost averaging your money in relative to those returns. Again, it’s okay in this scenario where you don’t have a lump sum to put in and you’re not gonna get the exact return for that year because you don’t have that money yet and you’re setting money aside with each paycheck, each time money comes over that waterfall and you’ve got that pool set aside and dedicated to be able to save for the future, for something in the medium and long term.

So that’s it. Dollar cost averaging. We’re just about to wrap up this cultivate your assets series. Many, many thanks to you for joining today. This is a wrap for episode 31. Happy day.

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Join Chief Financial Officer Ken Kaufman as he helps you track and hack your net worth. For those seeking financial independence, your net worth is one of the most significant measurements of success. Using his two decades of financial experience, Ken Kaufman helps you overcome your financial obstacles and look onward towards a better, brighter financial future.

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