Q. I inherited a large sum of money from my mother and want to invest it but with markets near highs and the state of the world a mess, I’m wondering if it would be better to ease into the markets over time instead of just jumping in and maybe taking a loss. — Steve in Satellite Beach
A. Steve, my condolences on the loss of your mother.
There is an adage that the market-timing hall of fame is an empty room. Predicting short-term changes to the market is notoriously difficult.
If having your account drop in value in the near term would cause you sleepless nights you may want to try a technique called “dollar cost averaging.” Sometimes it produces a better result than investing all at once, but it is not necessarily a cure for market jitters.
Dollar-cost averaging (DCA) is buying into a holding with a fixed dollar amount at fixed time intervals. For example, rather than buying $600,000 of a particular investment at one time, you could buy $50,000 a month of a holding for 12 months. If the price per share drops during that year, you buy more shares with each purchase while the price is down. That will be better than having bought all shares at a higher price.
That might sound good but for DCA to pay off, the market must decline and stay down long enough to get a lower average purchase price than that of a lump sum initial purchase. Because markets have risen more often than they have fallen, the many studies of DCA show jumping in at one time has produced the better result than a 12-month buy-in about 2/3rds of the time, regardless of how high the market was at the start.
The math tells us nothing about the psychology involved. No one likes market declines, but nervous investors really have difficulty with them. So much so that often, instead of viewing the drop as an opportunity to buy shares at a lower price, a market drop reinforces their fears. That is a problem because a drop is exactly what you need to get a better result when using DCA.
If you don’t buy when things are down, you may undermine the DCA technique at precisely the time it would be most effective. If you employ DCA, keep the time frame to a year or less and be committed to follow through and buy if there is a drop.
You should also note dollar cost averaging does nothing to prepare you for the long term. Averaging just delays being fully invested. Once the DCA period is over, all the money is subject to market risks.
Financial market behavior has always been volatile, and you should expect it to be so going forward. However, properly diversified holdings have always recovered from the drops and trended up over time even though there has always been a lot to worry about. If you cannot commit to truly investing for the long-term, you might not want to subject much, if any, of your inheritance to the persistent ups and downs of the stock market.
Investing should be a long-term endeavor. Get your portfolio properly diversified for your needs and focus on being patient and disciplined. Rather than guessing which way the market will move, in the long run you should be better off learning to be resilient rather than trying to be nimble.
Dan Moisand, CFP®, has been featured as one of America’s top independent fee-only financial planners by at least 10 financial planning publications and practices at one of America’s most decorated independent firms. Info: dan@moisandfitzgerald.com, moisandfitzgerald.com or 321-253-5400, Ext. 101.
Originally published on FloridaToday. Read the original article here.