Would you rather turn $100,000 into $200,000 or $500,000 into $1,000,000? The percentage returns in this scenario over time are the same, but we have two drastically different nominal numbers. I imagine everyone would choose to double their $500,000, but unfortunately for most investors, it takes a long time to accumulate $500,000 of investable assets. Market crashes benefit dollar-cost averaging strategies because they give opportunities to get money invested. Market crashes are scary indeed, but if you only have a small amount of money invested while the markets are roaring, you want the ability to put a lot of money while it is in decline. Dollar-cost averaging into market crashes create a forced and unemotional way for you to benefit in the long run.
Warren Buffet once stated in a shareholder letter:
If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.
This goes against the way we are wired as humans but can be explained by a concept called cognitive dissonance, or the state of having inconsistent thoughts, beliefs, or attitudes, especially as relating to behavioral decisions and attitude change. I face this every day when I tell myself I want to be healthy and lose weight, but then I give in to the instant gratification I feel from stuffing down a Big Mac. We see it in our financial lives where we overspend to enjoy today, rather than saving and delaying, ensuring a brighter future.
Buffet reminds us that we should not panic in times like this where the Dow Jones has shed 2000 points in 5 days. For the investors with time on their side, it is better to have a choppy market that benefits dollar-cost averaging strategies. It is indeed fantastic to watch your 401k appreciate from $100,000 to $200,000, however, the math suggests you want some setbacks allowing you to dump another $300,000 into the market before it goes on another 10-year raging bull run. The benefits of dollar-cost averaging can be seen over an entire market cycle. While the market is going down, your systematic savings plan and dollar-cost averaging purchases are helping cushion the fall. When the market starts to bounce back and go on an upswing, you now have more shares and more money invested to reap the benefits of a 10% return. Watching $200,000 grow 10%, after putting money to work in a downturn, shows a nominal return of $20,000, a much more meaningful dollar amount to someone. This growth of “real money” benefits dollar-cost averaging strategies and keeps you motivated.
For those with less time, focus on your cash burn and having the appropriate mix of growth, income, and cash. If you feel stressed or anxious in a period of decline like this, check with your financial advisor to make sure you are still on track to achieve your goals and don’t worry about the index and the headlines. Stay tuned for more or follow me @lifemanaged_.
