Q: I recently inherited some money and would like to use it as a long-term investment, but I’m not sure when the right time would be to invest the money. I guess I’m worried that I might put all the money into the stock market at the wrong time.
A: Thanks for this question. With the stock market being priced so high right now, I can understand why you may be unsure if now is the best time to invest. One approach that may help you feel more comfortable would be to consider Dollar-Cost Averaging as a strategy. Here’s what you need to know:
One of the best ways to take emotion out of investing is to create a plan and stick with it. One way to do that is through a systematic investment plan called dollar-cost averaging (DCA).1 Dollar-cost averaging is a process that allows investors to slowly feed set amounts of money into the market at regular intervals.
Dollar-cost averaging: An example
As a long-term strategy, one potential benefit of using DCA is that it can help ensure that your money purchases more shares when prices are low and fewer shares when prices are high. Over time, the result could be that the average cost for the shares may be less than the average share price.
Consider the hypothetical example below, which assumes you invest $50 per month in an investment for 12 consecutive months, and every month the share price fluctuates a bit. You can see that your $600 total would have bought you 42.5 shares. The average price per share, as calculated by adding up the monthly prices and dividing by 12, would have been $14.25. However, the average cost, as calculated by dividing the total amount invested by the number of shares, would have been $14.12 per share. Over the years, this method could potentially save you a lot of money.
Other long-term benefits of DCA
In addition, DCA can potentially offer the psychological comfort of easing into the market gradually instead of plunging in all at once. Although DCA does not ensure a profit or protect against a loss in declining markets, its systematic investing “habit” helps encourage a long-term perspective, which can be soothing for people who might otherwise avoid the short-term volatility of the riskier, but potentially more profitable, investments such as stocks.2
And last, DCA may help you make savvy investment decisions if you stick with it. For instance, if your investment rises by 10 percent, you will likely post gains because of the shares you’ve accrued over time. But if your shares decline by the same amount, take comfort in knowing that your next investment will purchase more shares at a lower price per share.
Lump-sum investing versus DCA
Although investing a regular amount each month may be a sound way to develop a regular investing habit, some experts say that it may not be the best way to manage a lump sum of money, such as a 401(k) distribution, a bonus or an inheritance.
As an example, consider the following situation: If you are 65 years old and you receive a $300,000 401(k) distribution and immediately reinvest the entire sum, can you afford to take a chance that the market will drop shortly thereafter? If there’s a sustained market decline, you might be left with a nest egg that is somewhat smaller than you had originally planned on. Over time, you might recover your investment, but you have to weigh the consequences of a potential loss before choosing lump-sum investing over DCA. Also, remember lump-sum investing the money does not earn anything if it is not invested in the market.
Regular investing makes sense
As a long-term strategy, you may find DCA allows you to feel more comfortable during uncertain markets than the lump-sum investing approach because it eliminates much of the guesswork — and emotion — associated with investing. In addition, DCA can help investors take advantage of the market’s short-term price fluctuations in a systematic way — by automatically buying more shares when prices drop and fewer shares when prices rise.
1Dollar-cost averaging involves regular, periodic investments in securities regardless of price levels. You should consider your financial ability to continue purchasing shares through periods of high and low prices. This plan does not ensure a profit and does not protect against loss in any markets.
2Investing in stocks involves risks, including loss of principal.
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*As reported by Financial Planning magazine, June 1996-2016, based on total revenues.
**Award based on 10 objective criteria associated with providing quality services to clients such as credentials, experience, and assets under management among other factors. Wealth managers do not pay a fee to be considered or placed on the final list of 2015 Five Star Wealth Managers
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.