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“Oh help, run away, run away” (the villagers run away).
But not Bob, Bob stayed.
And then Bob got eaten.
Whoa what an abrupt and sad story… hey speaking of! I knew a Bob once… he never got eaten by anything… but he was a builder come to think of it. “Rubs chin ruefully”.
AHEM. ANYWAY the moral of the above story is if a hungry bear comes looking for food in your village – sometimes being a hero doesn’t work, because being a hero can make you someone’s lunch.
This is especially true in the financial markets as well – yknow sometimes it makes perfect sense to run away and sell everything.
GET OUT WHILST YOU CAN – A BEAR IS COMING!
And then you look back in X years time and kick yourself for exiting at just the wrong moment – when there was mass panic and hysteria and Jenny from the neighbouring hut forgot to take her pots and pans again, whatever will she cook with? And is that Bob standing all by himself, why isn’t he hurrying to leave?
Hmmm… maybe there’s a middle ground somewhere? Between rushing for the exits and staying to fight the monster that’s coming?
There is! And so we introduce the concept offff….
Step 4 – Dollar Cost Averaging
OK OK, let’s rewind a bit, for you guys who have NO idea what I am on (a comfy cushion).
I’m just continuing with answering my friend Light Beam’s question on:
“How to survive a bear market”
It’s an interesting question and I’ve already written up a couple of responses to it, being “Step 1 – Don’t panic (read here)”, “Step 2 – Think wo(man) THINK (read here)”, and “Step 3 – Survive the initial wave (read here)”.
Go back and have a read of them if you missed out!
But today we’re gonna talk about a basic concept in investing – that being dollar cost averaging.
What is dollar cost averaging?
Yeah, what is it!
Well, dollar cost averaging (DCA) is when you invest a fixed dollar amount into a particular investment on a regular basis, regardless of price.
It could be Shares, Index funds, Cryptocurrency, even Women’s Maybelline (maybe she’s born with it).
Point is the investor (you and I) end up buying more when prices are low (on sale) and less when prices are high (over-priced).
The key theme here is consistency.
That is, to invest the same amount each time, every time.
Here’s how it works.
Let’s say we have three people at your workplace – Finicky Fred, Brainy Betty and Simple Sally.
They all have the same job, same income, same risk profile and same amount for investment ($100).
Finicky Fred loves to over-analyze everything, he’s a real hands-on type of guy.
Brainy Betty doesn’t make mistakes. Period.
Simple Sally prefers to just do the time, not worry and let everything run its course.
During an investment timeline, it might go something like this:
In May, the units cost $1 each.
In June, the cost of the units falls to 90c.
In July, the cost of the units again falls, this time to 75c.
In August, the cost of the units rises to $1.20.
So how did our colleagues at work do?
Finicky Fred – Fred bought 100 units@$1 in May, umm’d and ahh’d about selling in June, then watched the price drop to 75c in July, couldn’t handle it, sold everything and went to live with his cousin in Brazil, swearing to never touch investing again. 25% LOSS.
Brainy Betty – Betty gets it right each time. She waited and waited, biding her time… UNTIL SNAP, she bought $100 worth in July@75c for 133 units, then sold in August for $1.20. A whopping 60% gain.
Simple Sally – Sally likes the good things in life, good friends, good food, good wine, she doesn’t care too much about investing, just let’s it do its thing. She bought $25 worth in May for 25 units, $25 in June for 27 units, $25 in July for 33 units and $25 in August for 20 units.
This is where it gets interesting, Sally’s use of DCA means she would own 105 units. As the price of the units is now $1.20 (August cost), the total value is $126.
But the total cost over the 4 months was $100, which represents a solid 26% return.
I dunno about you but hey, I’ll take 26% returns by keeping things simple any day of the week! Sure we can try to be Brainy Betty’s but how many of us actually do! (I myself tried once, but ended up being Finicky Fred minus the escaping to Brazil part…)
There are risks to DCA (read here), the biggest being of course, not being consistent. Because it’s so easy to be scared off when prices are tanking isn’t it?
Truly a bear market is terrifying, it always is – the uncertainty, the volatility, the sheer brutality.
But you have to stay the course – use DCA to your advantage!
Investing doesn’t have to be hard or overly technical – sometimes the best strategy is just to stay simple.
It might mean hey in a few year’s time when we look back, maybe just maybe we don’t kick ourselves for jumping out at the wrong time, and give us a pat on the back instead for being BRAVE.
(But not brave like Bob…Bob got eaten… don’t be like Bob).
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Funnily enough, for the majority of us Aussies – we already have one of the best examples in dollar cost averaging without us realizing.
This takes the form of superannuation (American cousins please note, it’s kinda like a 401k account).
For most of us working Down Under, each paycheck, our employers contribute 9.5 per cent of our salary to superannuation. This contribution is invested into our investment options within our superannuation account.
The default being “balanced” – which isn’t the worst option actually as you get a bit of everything, stocks, bonds, international exposure, Women’s Maybelline (maybe not the last part).
Please note DCA is to be used as a guide only, you must, must, MUST do your own research to see if it suits you.