Despite overwhelming market volatility in recent months, there is one strategy that long-term investors have been using to ensure their portfolio will grow
I am awoken this morning by the reassuring rays of sun shining through the slits in my bedroom curtains, as birds chirp gleefully unfazed by the roaring pandemic that engulfs the world. But today is a good day, because my commute is short (about 9 feet in fact), and my portfolio is starting to show flashes of its old self.
Despite the social distancing of our favorite stocks from a ticker-adjacent green number in recent weeks, the market had a rare good day yesterday. The S&P 500 (NYSEARCA: VOO) had its best day since 2008 with a 9.4% gain, while the Dow Jones (INDEXDJX: .DJI) had its best single-day percentage gain since 1933, rising 11%.
All the big names were up too: Tesla (NASDAQ: TSLA) rose 16%, Apple (NASDAQ: AAPL) jumped nearly 10%, and Nike (NASDAQ: NKE) rallied 15%. Even Virgin Galactic (NYSE: SPCE) seemed to be back to its usual self following a 25% gain.
All of this market confidence could be attributed to the Government finally reaching an agreement on a $2 trillion stimulus package to boost the economy. However, as investors will have been made painfully aware of in recent months, there is no predicting what the market will do next and optimistic days such as these should be enjoyed while they last.
But none of this really matters to long term investors following one simple strategy…
What is Dollar Cost Averaging?
It is very important to consider dollar cost averaging, especially with a potential recession looming on the horizon. Dollar cost averaging is:
Investing a fixed amount of money in the same fund or stock at regular intervals over a long period of time.
It is a great way for investors to take back a bit of control over the current market madness that has gripped Wall Street. All investors need to do is plan interval payments into their portfolio, choose the stocks they wish to invest in, and then most importantly:
Be persistent!
In theory, by consistently investing in an index fund, one will be able to capture the good days, the bad days, and the just plain boring days. But as long as it is consistently done, the portfolio should average out over time, which will allow investments to ride the market wave back up, because as we know; the market always rises in the end.
Does dollar cost averaging work?
The practice of dollar cost averaging is one of the few strategies in investing that can almost guarantee positive returns over time.
Let’s look at Netflix (NASDAQ: NFLX) for example. This 170 million subscriber-strong media giant used to send out DVDs via mail. Who would’ve thought? Well, when Netflix IPOd in 2002, one share went for a very affordable $15. Over the next 18 years, due to compounding and several stock splits, the stock has grown close to 35,000%, even despite recent volatility and the rising threat of Disney (NYSE: DIS). So if you invested $15 on its IPO, that one share would be worth more than $5,000 today.
Of course, that’s easier said than done, and if we could all predict such gains then we’d all be millionaires. What you can do though, is systematically invest in a company you believe in, such as Netflix, and add to that investment, and over time you would have built yourself a pretty impressive portfolio. Let’s give a conservative example:
If you invested $20 per month for 20 years, and assuming your investments yield the average 10% annual returns the S&P 500 does, then you will have just under $14,000 from a total investment of $4,800. Not bad right? And that’s assuming you’re only investing in the S&P 500, you could be doing this with several companies or ETFs at once.
Why does dollar cost averaging matter?
It’s a tried and tested formula that millions of successful investors around the world have used and allows one to consistently build and strengthen their portfolio. It also eliminates the issue of market timing, which can be the downfall of any investor. It guarantees returns based on the overall trend of the stock rather than volatility and timing, and if an investor believes in that stock and has done their research, this should provide positive returns.
MyWallSt operates a full disclosure policy. MyWallSt staff currently hold long positions in companies mentioned above. Read our full disclosure policy here.