2015 was not the best show for the stock market. The S&P 500 ended the year up only a mere 3 percent. That may seem like a tiny return, especially when considering that not too long ago in 2013, the index surged 30 percent. This year has been similar (albeit slightly better) with the markets up but still only single digits.
Volatility last year is best shown by the Dow Jones Industrial Average which, in the first six months of 2015, was never up or down more than 3.5 percent, something that had never happened before. Within that tight range, the Dow crossed its break-even point more than 20 times by late July. This year we started off with a market correction before everything turned around and started to rise, with a few hiccups like Brexit along the way.
The reaction of many investors to these market conditions has been to do nothing, stop investing or, worse, get out of the market altogether. Liquidating your investments at a volatile time is a terrible investment strategy. Investors who flee the market in this type of panic induced selling are reacting in a way that does a lot of harm to their portfolio and chances of financial success.
No one can time the market (buying low and selling high) consistently over any meaningful length of time. So, how does an investor succeed during these periods of volatility?
A strategy that many experts favor is dollar cost averaging. This takes a lot of the fear out of investing in stocks because it's a long-term strategy that takes volatility into account. The key, in dollar cost averaging, is to stick to a regular investment plan by buying at preset intervals and ignore the market gyrations. By doing this you will buy both when the markets are up and when the markets are down. This is especially helpful when we are in a bear market as you can buy more shares for your money.
Here's an example to help understand a little better. Suppose, you plan on investing $25,000 each quarter for a year. If the stock starts out at $100/share you will be able to buy 250 shares. Assume also the market goes down in the second quarter, and you pay $90/share during the second purchase. The third quarter gets worse, and you pay $70/share. Finally the market recovers and the shares end the year at $90/share. During that time you were able to accumulate 1,163 shares worth $104,670. Not only do you own more than the 1,000 shares compared to making the total investment all in the first quarter but your shares are worth more too even though the price actually decreased from the start of the year by $10/share.
In the end, the winners in the investment game are those who stay the course and continue to invest, no matter how volatile and crazy the market seems. The losers have invariably been those who sell out after sharp stock-market declines just like what we experienced in 2008 and subsequently buy back in when the markets rebound.
Using dollar cost averaging helps avoid the risk of putting all your money in the stock or bond market at the wrong time. It ensures that at least some of your investments will be made at or near market lows.