Precept Employee Benefits Blog

Do you believe in dollar cost averaging to minimize market risk while maximizing potential returns?

For those of you who aren’t familiar with the concept, simply stated, dollar cost averaging is consistent investment of  set amount of money in periodic intervals to reduce market risk.  Instead of investing a lump sum trying to time the market, dollar cost averaging spreads out the investments over time and minimizes the negative impact of market fluctuations while taking advantage of the increase in purchase power during down market cycles.

With the above in mind, Precept RPS has consistently included the topic of dollar cost averaging at every employee educational meeting.  However, whenever dollar cost averaging is mentioned or explained, plan participants usually give a look of skepticism or disbelief.  They have a difficult time believing that there’s a potential for investment gain even when the market is substantially down for the year.

To help prove that this concept applies to everyday investors and especially to 401(k) participants who practice dollar cost averaging through payroll deductions, I conducted a little experiment.  I have been tracking 2 mutual funds for the past 11 months, the Schwab S&P 500 Index E Share fund (SWPEX) and the Fidelity Spartan Ext. Market Index Inv fund (FSEMX).  On September 11th, 2008, just prior to the market crash, a share of the Schwab S&P 500 Index fund was $18.98 and a share of the Fidelity Spartan Ext. Market fund was $36.55.  However on July 22nd, 2009, each respective share price was $14.87 and $25.56.  That is a decrease in price of 21.65% and 21.74%!  Yet, as the cliché goes, it’s all about the journey, not the end results.  What if, starting in September 2008 until July 2009, I invested $100 in each fund on the 11th and 22nd day of the month?  How much would I gain or lose?

It may be shocking, but even though the Schwab S&P 500 fund was down about 25% in that time period, through dollar cost averaging, I was up 8.26%.  Similarly, for the Fidelity Spartan Ext. Market fund which was down 28.02% for that time period, I was up 12.78%.  All I did was automatically invest $100 every 11th and 22nd day of the month.  This shows the advantage of practicing dollar cost averaging by increasing your purchasing power during down market and realizing positive returns during the recovery period.

Now, do not use this example as a guarantee that you’ll always realize investment gains.  The purpose of dollar cost averaging is to minimize risk and maximize your potential for investment returns   Instead of guessing when the market is on the rise or fall; this steady approach incurs all the highs and lows in order to balance out the risk.  As we move through this volatile market period, plan participants will realize that dollar cost averaging is applicable in theory and in practice.

For more information:

Dollar Cost Averaging: A Technique that Drastically Reduces Market Risk

Does Dollar Cost Averaging Work?