Making Money The Old Fashioned Way

Over the years investors have been bombarded with asset allocation, rebalancing, tactical allocation and the use of commodities and other exotic investments. It has gotten so confusing and so sophisticated that the average investor often gives up or tries to emulate a complicated allocation utilized by governments or hedge funds. It’s time to revisit and understand that simple works and is often all anyone really needs to make money.

When I was teaching investment management at the Adult Ed one point I would make was that a lump sum investment over a significant length of time always outperformed investments made monthly over the same period of time. The last 10 years with two major market meltdowns proved that statement wrong.

In fact, using a mutual fund that matches fairly well with the S&P 500 index someone who invested a lump sum in January 2000 versus someone who invested that same amount spread out monthly over the following 120 months found a significant difference in return. The lump sum investor earned a paltry .33% per year while the monthly investor averaged a staggering 3% per year. Yes, dear reader, the lump sum investor earned about a third of a percentage point a year!

The old joke on how to get to Carnegie Hall, practice, practice, practice. Let’s use that on how you can make money with your 401k, IRA or 403b. The answer is invest, invest and invest consistently.

The folks who made it through the latest depression, as scary and deep as it was, were those  who kept on doing the very same things that they were doing before the crisis came knocking on our door.

I am willing to bet that everyone out there knows at least one person that said that he or she was never going to invest in the stock market again and stopped their 401k or IRA, or whatever it was that they were consistently investing in and is sorry about it today.

The winners were those folks that kept on buying shares with the same amount of money that they had earmarked before the depression hit. This consistent method of investing is as old as I am, which makes it an ancient and simple method of wealth  building. The people who followed that principal are either even or close to it or in some cases (depending on the account size), ahead of where they were eighteen months ago.

Dollar cost averaging is what professionals call systematic investment. You choose a singular amount, a particular investment and allow it to buy each and every month. In most cases, for the first few years, the investor contribution will probably buy the same number of shares per investment but as time goes on something interesting happens and the amount of shares per same dollar investment decreases. There are even peculiar moments where for a month or two the systematic investments happen to buy an extraordinary amount of shares for the same amount of money. These are explained as market dips, much like we had when GS was accused of cheating customers.

Over an extended period of time and as long as you are investing in a mutual fund and not a singular stock there is a significant gain, although it never really matches the actual fund’s annual performance. And this is because the dollars invested have different ages, 12 months, 11 months, 10 months, etc.

One writer tried to explain that dollar cost averaging would gain an investor a consistent 10% per year but that’s impossible. The actual average is far less because of how the money is being invested. It is a time and money thing and if I had a chart I’d show but you’re there and I’m here so just take my word for it.

What dollar cost averaging does is buy at all price ranges, catch good and bad share prices and has a remarkable ability of reducing the cost of shares over an extended period of time. What it does not do is have an ability of making someone rich. It’s very design of buying systematically prevents that.

In down years dollar cost averaging works better for investors than lump sum simply because of catching different and lower share prices and not committing dollars at the higher share price. Over greater time periods this disadvantage reduces considerably.

And, as we discovered by doing some basic math the last 10 years favored the systematic investor. The next 10 may not but no matter, investors may have finally learned that to stay the course is the best advice of all.

If you have questions call Paul at 877 783 7080 or write pstanley@westminsterfinancial.com Share this blog with someone who cares about money.