The markets closed last week at all-time highs on June 2, 2017. While that is wonderful news for those who are invested, it poses a problem for investors with new money. Investors who have received an inheritance, insurance settlement, or a bonus, or even those who just rolled over an account have the challenge of deciding when to invest their cash into the market.
In general and in all market conditions, Henssler Financial recommends dollar cost averaging (DCA) your money into the market. When you DCA, you invest a fixed dollar amount at set intervals over a long time period. This method often lowers your price per share by taking advantage of market lows and highs. However, when you have a market that is setting new records every few days, how do you choose when to invest? When markets are rising, dollar cost averaging begins to feel a lot like market timing—i.e., trying to guess when is the best time to get in.
There is no right way to move money into the market that works across the board for every investor. We like to begin with how the investor feels about the market. Some may be bullish, thinking the market is going to continue to rise, while others may feel the market is well overdue for a pull back. This often determines whether an investor chooses to dollar cost average over 12 or 18 months, and if investments are made monthly or quarterly. When the market is at a high, some investors may want to use a little more time, especially if you consider that the market dips by 5% three times a year on average.
It is also important to remember to stay diversified across multiple sectors. You may choose to allocate less money to sectors that have over-performed while allocating more money to areas that have under-performed. You may also want to accelerate your investment into dividend paying stocks. Even if the market were to pull back, the dividend would still provide a cash flow.
When investing rollover money, you should also consider how it was previously invested. Often when money is rolled over from a 401(k) or similar account with limited investment choices to an IRA, some investments may be sold, so there is likely a good bit sitting in cash. If the money was invested for growth—meaning it has a long time horizon before it is needed—you may want to accelerate your DCA schedule. With fixed-income investments and cash yielding very little return in the current low interest rate environment, you may not want long-term money sitting on the sideline for very long.
Overall, when you dollar cost average into the market, you are primarily trying to accomplish two things: lowering your average cost per share and minimizing the risk of entering the market at an inopportune time. Over a 12-month period, you have opportunities to take advantage of market dips, buying more shares when the price is down—you are not at the mercy of one trading day.
Dollar cost averaging works well in volatility, but may yield a lower return when the markets are consistently rising. A portfolio’s return will trail the market when an investor has money sitting in fixed income or cash. While you may not accomplish the goal of a lower cost per share, dollar cost averaging is still a relevant risk management technique.
It can be hard to place a quantifiable value on reducing the risk in a portfolio, especially when performance is trailing the market. It is impossible to know what the market will do on any given day; therefore, we would almost never recommend going all in at once. If reducing the risk in your portfolio is an important part of your investment plan, dollar cost averaging regardless of the market conditions is a good method to follow.
If you have questions regarding dollar cost averaging your money into the market, the experts at Henssler Financial will be glad to help: