The S&P 500 index is down more than 18% over the past 12 months and many individual investments, such as prominent tech stocks and cryptocurrencies, have faired far worse, except that crypto has increased in price more than 60% from the start of this year.
The stock market downturn is enough to cause many investors to panic, however the most market experts will tell you to do the exact opposite.
Investing in a down market
A down market is actually an ideal situation for a relatively new and young investor who has signed up for a dollar-cost averaging approach.
A traditional long-term investing approach called dollar-cost averaging entails making regular, fixed investments into your portfolio.
According to statistics, since World War II, the stock market has increased in 73% of the years. You must therefore assume that if the market declines one year, it will likely increase the following.
It is impossible to predict if the stocks will recover in the near future. However, the broad stock market has consistently trended upward over a lengthy period of time. Consequently, purchasing stocks at a bargain means doing so when they are on the decline.
Investors often don’t have to wait very long to bounce back from the kind of bear market we’re currently seeing.
Market bounces back in 27 months
In the 10 times that’s happened since 1945, the market has bounced back to breakeven in 27 months, on average.
Investors can benefit from stock market history by being aware of how quickly the market bounces back after significant selloffs. Your anxiety may decrease once you realize you’ll return to breakeven.
It’s crucial to note that the data presented above only relates to the SP500 index as a whole, not to specific equities, which have the potential to go completely down the drain and never rise again. But buying near the market’s bottom means you’ll earn better returns when it eventually finds its way to new highs, assuming you have a well diversified portfolio.
This does not necessarily mean that the market has reached its bottom. In the near future, it might rise again from here or keep tumbling. By eliminating market timing from the equation, dollar-cost averaging can be helpful in this situation.
You can be sure that over time, if you continuously invest the same amount of money in a broadly diversified portfolio, you’ll buy more shares when they’re less expensive and fewer when they’re more costly.
Additionally, it is best to start investing regularly as soon as possible. Younger investors benefit from having time on their side since the longer you invest, the more time your portfolio has to multiply.
Say you invest $1,000 today and $300 a month thereafter. If you retire in 45 years, assuming an 8% annualized return on your investments, your portfolio would be worth over $1,500,000.
Were you to to make the same contributions and earn the same return, but wait five years to get started, your portfolio value would fall to just over $1M.
So the faster your start the better. As the saying goes:
“The best time to start was yesterday. The next best time is now.”
Dollar-cost averaging vs. lump-sum investing
Dollar-cost averaging and lump-sum investing are two different investment strategies that investors can use to invest in the stock market or other assets.
Like dollar-cost averaging, lump-sum investing can also help you build wealth — and even better, maximize your returns — although with the caveat that you’re taking on much more risk. After all, as we all know, no one can really time the market.
With dollar-cost averaging, you invest a fixed amount of money at regular intervals, regardless of the current market price. For example, you might invest $500 every month into a mutual fund or exchange-traded fund (ETF). This approach can help you avoid the risk of investing all your money at once and potentially buying at a market peak.
With lump-sum investing, you invest a large sum of money all at once. For example, you might invest $10,000 into a mutual fund or ETF in a single transaction. This approach can potentially generate higher returns if the market rises after you invest, but it also carries the risk of investing at a market peak.
Advantages of Dollar-Cost Averaging:
– Reduces the risk of investing all your money at a market peak
– Can help you avoid emotional investing decisions
– Can potentially result in a lower average cost per share over time
Disadvantages of Dollar-Cost Averaging:
– May result in missing out on market gains if the market rises after you start investing
– Requires ongoing discipline to maintain the investment schedule
Advantages of Lump-Sum Investing:
– Can potentially result in higher returns if the market rises after you invest
– Requires only a single transaction
Disadvantages of Lump-Sum Investing:
– Carries the risk of investing at a market peak
– Can result in higher average cost per share if the market declines after you invest
Ultimately, the best approach depends on your individual circumstances, risk tolerance, and investment goals. It’s important to consider your options carefully and consult with a financial advisor before making any investment decisions.
Is the dollar-cost averaging strategy right for you?
When investing with any method or strategy, the first step is to identify the potential returns as well as your risk tolerance.
Though you may get better returns over time with lump-sum investing, it’s not a good idea for those looking to lower their short-term downside risk since the potential for loss is greater is market will be going down right after your investment.
