There is no shortage of financial news right now. Tariffs and trade negotiations are dominating the media. There are conflicts in the Middle East and Ukraine. And the stock market has made headlines for big price swings. But I have good news: There is an investing approach that’s designed to help you take advantage of increased volatility.
Let’s explore how dollar cost averaging can help you navigate volatility.
Dollar cost averaging, sometimes abbreviated as DCA, is when an investor sets a recurring fixed dollar investment at regular intervals. The financial services industry likes to create fancy jargon to explain simple concepts. Simply put, dollar cost averaging is as straightforward as regularly investing a portion of your paycheck into a 401(k) or Roth IRA.
Why is dollar cost averaging worthwhile? Because you’re taking advantage of the market’s price fluctuations. By investing a fixed amount on a monthly basis, you avoid investing a large lump sum at market highs, and more importantly, you have the ability to purchase additional shares during market weakness. By investing in down markets, you are effectively shopping at the clearance rack – who doesn’t like a 15 percent discount? The markets have recovered from some challenging events, including 9/11, the tech bubble, the global financial crisis and Covid. When a recovery occurs, purchasing shares at a discount can result in significant returns. When it comes to investing, time is on your side.
I cannot walk around a Beagle Club without my friends asking me, “Bryson, I’m about to retire. I don’t have time to recover. What should I do?” It’s human nature to create timelines. Our financial plan outlines an exact date for retirement. Many people circle the date on their calendars. I’ve had clients download countdown clocks, eagerly anticipating their retirement date.
No doubt, this is an exciting milestone. And as we get closer to our retirement, volatility often tends to become more concerning. But it’s very important to remember that your retirement date isn’t the end of your plan. A financial plan shouldn’t concentrate solely on getting you TO your retirement date; a well-drafted financial plan should focus on getting you THROUGH retirement.
One of the most common mistakes I witness in my profession is transitioning investments into conservative assets at too young of an age. For many retirees, the single largest threat to their retirement is inflation, the increased cost of living. If you retire at age 62 and live to 95, your portfolio needs to support 33 years of retirement income. How much will the cost of living increase over a three-decade period?
Let’s discuss how a multi-bucket approach can help address near-term volatility while helping offset future inflation.
A well-written investment policy statement will break down your investment strategy into three categories: near-term needs, middle-term needs, and, you guessed it, long-term needs.
Near-Term Needs: These are your immediate needs; consider this your emergency fund. These assets are often set aside in very conservative assets, such as a money market or high-yield savings account. They will not earn much, but they are readily available.
Middle-Term Needs: Think of planned expenses in the one- to five-year range, such as purchasing a car or retirement income needs. These funds are often invested in fixed-income assets, such as bonds, which have a little more risk than money markets but also tend to generate a higher return. This bucket can act as a volatility buffer. By having three to five years of retirement income needs in bonds, you are not forced to sell stocks at depreciated values to meet ongoing retirement income needs.
Long-Term Needs: Typically, this is retirement income that will be required more than five years in the future. These assets are invested into more aggressive asset classes, such as stocks, with a potentially higher return potential. This bucket helps offset future costs associated with inflation.
Bryson Roof, CFP, is a financial advisor at Fort Pitt Capital Group in Harrisburg. Fort Pitt is a division of Kovitz Investment Group Partners, LLC, a registered investment adviser with the Securities and Exchange Commission. SEC registration does not constitute an endorsement of the firm by the commission, nor does it indicate that the adviser has attained a particular level of skill or ability.
