Automatic Investment Plans: A Systematic, All-Weather Strategy
Learn how a program of regular investing, known as dollar cost averaging, can help you weather market declines.
Seeking a strategy for investing during a down market? A plan of systematic, or regular, investing can help you take advantage of changing market conditions — and avoid the futile approach of trying to time the market.
Dollar Cost Averaging Basics
Regular investing can help you cope with the human tendency of hesitating to invest in a declining market, when stock prices may actually be more reasonable.
With an automatic investment plan, known as dollar cost averaging, an investor invests the same amount at regular intervals — for example, $500 each month — regardless of whether stock prices rise or fall. Using this strategy, investors can buy more shares at lower prices and fewer shares at higher prices.
A program of regular investing can help take the emotion out of investing when markets turn particularly volatile because your long-term strategy doesn’t change. There is no need to make a drastic adjustment. In fact, taking money out of the market or ceasing to invest during declines might result in selling low or missing the chance to add to a portfolio when prices are down.
"In my 34 years, I’ve seen a lot of market cycles and lived through some very volatile periods. With experience, you begin to understand that none of us can predict what the market is going to do in the short term," says Tim Armour, chairman and CEO of the Capital Group. "The most important lesson I’ve learned over time is that you have to contain your emotions. Sticking with the fundamentals, employing good asset allocation, and maintaining a balanced portfolio with a long-term horizon is the best approach."
The Benefits of Dollar Cost Averaging
To illustrate the potential benefits of dollar cost averaging, take a look at the table below. In this example, an investor bought shares of a mutual fund at three regular intervals, paying $15, $10 and $20 per share. When the price fell to $10 per share, the investor bought more shares. When it rose to $20 per share, the investor bought fewer shares.
When Prices Fall, You Can Accumulate More Shares
The key is that the average cost of the shares was $13.85 per share, whereas the average price on the market was $15 per share. This means that the investor was able to avoid paying an average of an additional $1.15 per share simply by investing regularly and using the power of dollar cost averaging.
Of course, to take advantage of a systematic plan, investors must be willing to stick to the strategy during bad markets. Regular investing does not ensure a profit or protect against loss, and investors should consider their willingness to keep investing when share prices are declining.
An Automatic Investment Plan in Action
Now that we’ve discussed the potential benefits of dollar cost averaging, let’s look at how a systematic investment plan might have worked for an investor during the past two decades. For example, consider a hypothetical investment of $500 at the end of every month in Standard & Poor’s 500 Composite Index, with all dividends reinvested, over the 20 years ending on December 31, 2018.
During the 20 years of this hypothetical investment, there were periods of market declines with various highs and lows. But at the end of those 20 years, the investor would have built up an account balance of $279,819.