Taking the Guesswork Out of When and How Much to Invest

Jun 28, 2023
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No matter which SMI strategy (or strategies) you follow, two questions remain: “How often should I invest?” And “How much should I invest at a time?” A simple way to make these decisions is to use a “formula” approach that eliminates inconsistency and guesswork.

The best-known formula for answering the how much/how often questions is “dollar-cost averaging” (DCA). Here’s all you do: (1) invest the same amount of money (2) at regular time intervals.

Those guidelines don’t fully answer the questions of “how much” and “how often,” but they create a framework that’s easy to follow. For example, you might choose “$800 a month” or “$500 per pay period.” The important thing is to pick an amount you can stick with faithfully.

DCA frees you from worrying about whether you’re buying stocks at the “wrong” time. Because your dollar amount remains constant, you’ll get more shares for your money when stock prices fall and fewer shares when prices rise. In effect, you’ll buy more shares at “bargain prices” and fewer at what might be considered high prices. (Of course, only when you look back years from now will you know when prices were indeed bargains and when they were too high.)

For DCA to work, however, you must ignore market fluctuations. Most investors who suffer poor returns over the long haul are victims of their emotions. They work up enough courage to buy only after stock prices have risen sharply. Then, when prices plunge, they become fearful and sell. Consequently, they “buy high and sell low,” the opposite of their intention.

It is crucial, therefore, not to let your emotions control you. To use dollar-cost averaging effectively, you must exercise the discipline of maintaining your systematic investment program.

DCA cautions and critics

DCA results in your average cost per share being lower than the average price of the shares over time, but it isn’t a cure-all. For one thing, DCA doesn’t protect you against losses. You can still suffer temporary setbacks from a bear market.

Furthermore, DCA could diminish your profit potential. Let’s say you invested each month in a mutual fund for which the share price rose steadily all year. That’s great, but if you do the math, you’ll discover you would have enjoyed more significant gains if you had made a single large investment early on rather than making smaller, consistent investments over time.

The “do-the-math” comparison has led some analysts to argue that, since the market has a long-term upward bias (i.e., it has always moved higher eventually), DCA isn’t a great idea if investing sooner is an option. They note that you’ll pay more for shares (on average) if you stretch out your buying than if you invest as much as you can as soon as you can.

However, the “optimal” approach these analysts prefer ignores that bear-market periods frighten many investors out of the market altogether! Suppose, for example, you received a $50,000 inheritance (yay!) and invested it immediately. Unfortunately, you did so just before a bear market took hold and wiped out $10,000 of the money (yikes!).Would you have the stomach to stay around, trusting that you’ll recoup your losses and move into the black during the next bull market? Perhaps, perhaps not.

Although academic number-crunchers may have it right in theory, in the real world, investing smaller amounts over time makes it easier for investors to overcome their fears and continue to put their money at risk even at times of market weakness.

DCA and the SMI strategies

Dollar-cost averaging works easily with two of SMI’s core strategies: Just-the-Basics (JtB) and Dynamic Asset Allocation (DAA).

For Just-the-Basics, the mechanics of dollar-cost averaging will vary somewhat depending on your broker and the type of funds you use. DCA is most efficient when an investor is able to buy “fractional” shares because every penny of each DCA investment will be “put to work” immediately. Since all traditional mutual funds allow the purchase of fractional shares, using JtB’s traditional fund recommendations in conjunction with DCA is ideal, whether using our “official” Vanguard recommendations or alternative JtB traditional funds from another company, such as Schwab.

That said, you can implement dollar-cost averaging efficiently using JtB’s exchange-traded fund (ETF) recommendations if your broker allows fractional-share purchases of ETFs. Fidelity added fractional-share trading of ETFs in 2020 and Vanguard followed suit last year. (Although Vanguard allows fractional ETF purchases only for its in-house funds, that’s fine for JtB investors with accounts at Vanguard because all of the Just-the-Basics recommendations are Vanguard funds. JtB investors can choose Fidelity- or Schwab-branded alternatives if they wish.) At most other brokers, it’s better to stick with traditional funds.

The issue of fractional shares also comes into play when using dollar-cost averaging with Dynamic Asset Allocation. DAA uses exchange-traded funds exclusively, rotating among six ETFs, each representing a specific asset class. (Only three DAA funds are recommended at any given time.)

A DAA investor at Fidelity can put every cent of each dollar-cost-averaging investment to work immediately by purchasing fractional ETF shares. The same is largely true for DAA investors with Vanguard. Two of the six ETFs used in DAA are Vanguard funds, so Vanguard customers can buy fractional shares of those ETFs. In addition, Vanguard offers in-house alternatives for three of DAA’s non-Vanguard recommendations. So Vanguard investors have only one DAA fund — a Gold ETF — that can’t be purchased on a fractional-share basis.

Although SMI investors implementing DAA via other brokerage firms can use dollar-cost averaging, the purchase process will be slightly less efficient since fractional shares aren’t available. Once a DCA investment has bought as many whole shares as possible, any remaining cash will stay in a sweep account until more money is added and more whole shares can be purchased.

DCA also can be used with SMI’s Fund Upgrading strategy, but it’s not as easy to implement. For one thing, Fund Upgrading typically invests in roughly 10 different positions (seven stock, three bond), making it more cumbersome to manually spread each purchase across so many funds. Secondly, as SMI readers have experienced over the past 18 months, Stock Upgrading sometimes shifts to cash during bear markets, undercutting some of the “buy low” potential of a DCA plan. (The SMI Fund may be an attractive “one-stop-shop” alternative for those wishing to DCA into Stock Upgrading.)

Reasons to like DCA

In summary, dollar-cost averaging is the systematic investment of a fixed amount of money regularly. It has these benefits:

  • DCA eliminates the need to ask, “Is this a good time to buy?” As far as dollar-cost averaging investors are concerned, every month is a good time to invest!

  • DCA imposes a discipline — a structure for making “installment payments” on one’s future financial security.

  • DCA causes you to buy relatively more fund shares when prices are low and fewer when prices are high.

  • DCA helps “automate” your investing, thus eliminating the risk that you’ll forget or be distracted by market news.

Dollar-cost averaging is also an excellent technique for 401(k) and 403(b) retirement-plan investing, especially if you can implement a Just-the-Basics approach or have access to other funds that provide diversification that reflects the stock market at large. 

There’s no single “right” way to employ DCA — the timing and amount are up to you. However, consistency is the key. Remember Proverbs 21:5, “Steady plodding brings prosperity” (TLB).

Written by

Austin Pryor

Austin Pryor

Austin Pryor has 40 years of experience advising investors and is the founder of the Sound Mind Investing newsletter and website. He's the author of The Sound Mind Investing Handbook which enjoys the endorsements of respected Christian teachers with more than 100,000 copies sold. Austin lives in Louisville, Kentucky, with his wife Susie. They have three grown sons and many grandchildren.

Joseph Slife

Joseph Slife

Joseph Slife has been a news writer for the Associated Press, a college instructor, and a radio host. He and his wife Joye have three grown sons.

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