As a financial advisor I’ve seen hundreds of investors ranging from inexperienced to advanced. I’ve seen people lose money and I’ve seen even novice investors make a lot of money because they got lucky. I’ve seen average investors make great gains throughout their earning years only to later make a mistake. Stock market gains seem to be non-discriminatory. Anyone can make money in the markets. Success in investing is shared by both young and old investors, those who read investment magazines and those who pick random stocks or funds they like.
All too often after someone has made a little money in the markets or even before they’ve capitalized on the investment opportunity, they let their emotions get involved in the investing process. What novice investors don’t realize is that they need to be able to invest strategically without letting their emotions railroad their goals. There is a term for this phenomenon in the investment community called behavioral finance. Behavioral finance describes the different ways that investors are led to act based on their emotions.
Perhaps one of the worst behavioral finance problems is when investors buy high and sell low. The natural tendency is for investors to buy a stock at its peak because they know it’s performing well. As the stock corrects or underperforms investors sell it off because they’re scared that it could devalue even further. Unfortunately, this is exactly the opposite of good investing practices. Rather than buying at peak and selling at trough, investors should buy low and sell high.
You can correct this problem, differentiate yourself as an investor, and experience greater returns in the stock market by practicing one of the oldest forms of investing called dollar cost averaging. Dollar cost averaging is a big phrase for a very easy practice. It simply means to buy into the markets on a regular basis. For many people this looks like having their employer send money directly from their paycheck to a retirement account. For others it could be a more advanced strategy. For instance, if Brad inherited $100,000 from his mother in a cash account and he would like to invest it all in an up-and-coming tech company, he’d be wise to dollar-cost-average. He would do so by investing $25,000 every three months for a year. If the price of the stock was $40 in January, $43 in April, $35 in July, and $39 in July then the average cost per share of his investment would be $39.25, a full $0.75 cheaper than if he had simply invested the full $100,000 in January. Obviously, this is a very simple example, but still accurate because although over time the stock market has always appreciated, there are periods of recession and individual stocks can fluctuate a lot.
The power of dollar-cost averaging is that it reduces the volatility of the overall purchase and it instills in the investor the practice of continually buying into the market. This is a powerful strategy that will help you grow your wealth and experience more gains in the markets. An even more advanced strategy would be to hold your money until you see the stock market or the particular stock dip and then buy more of it. When coupled with dollar-cost averaging this can be a very lucrative form of investing.
When you avoid emotional investing and you practice dollar-cost averaging you can invest for superior returns by buying low and selling high.