Take Advantage of a Declining Market
You’ve heard it a million times, but the average investor who saves regularly by contributing to a 401(k) or IRA every paycheck can benefit from reduced volatility because of dollar cost averaging. If you plug away and invest $100 each month regardless of what the market is doing, you’ll be utilizing the same amount of money, but buying more shares when prices are low, and fewer shares when prices are high. Over time, this averages out your purchase price and eliminates some of the risk (a more correct term would be volatility) with trying to time the market.
Now, this isn’t a difficult concept to understand, but many people fail to realize how this can help them, and will do completely the opposite. They will abandon their regular investment plan and contribute more to their investments when the markets are doing good, and reduce their contributions when markets are bad. This makes your average purchase price much higher since you’re stocking up when prices are high, and buying less when prices are low! The end result is that over time, you’ll significantly hurt your total returns.
Don’t Be One of These People
Over the past week, I’ve received a lot of calls and met with a number of concerned investors. With all that is going on in the world of finance, it doesn’t really surprise me that people are a little stressed out. But what does surprise me is the completely backward way of thinking when it comes to how much they should be contributing to their retirement plan.
The most common action I’m seeing from investors is people who are reducing the amount of money they save each paycheck. That’s right, the market has taken a dive, and their investments are around 20% cheaper than they were a year ago, yet people think the best course of action is to save less. I’m not exactly sure what the rationale is for this behavior, but I guess some people think that their money could be better served not going into something that has been decreasing in value. I think that goes with the inability for some people to focus on the long-term rewards. Yes, in the past year it may have been painful to see your balance decrease, but that shouldn’t overshadow the fact that by continuing to plug away at saving, you’ll find yourself in a much better situation 25 years from now.
The other common behavior I’m seeing a lot of are those who stop their contributions completely. The market has them so scared that they feel saving nothing is better than saving something and getting a match with the possibility of losing money. I have to wonder, if someone who’s saving 10% of their paycheck suddenly stops saving completely, what are they doing with the additional $100 or so per paycheck? If it isn’t going into the bank, or straight to paying off debt, chances are it’s just getting blown into the wind on purchases that they were doing without while saving, resulting in a 100% loss. If you’re giving up free match money on top of that, you’re really losing out.
Think of Your Investments Like Groceries, Not a Bank Account
The problem is that people view their investments, or retirement accounts as a bank account because every day, every month, or every quarter, you receive a statement that attributes a dollar amount to it. Just like your bank account, you see that balance as the bottom line, and you hope it doesn’t go down. This is the wrong way to look at your investments, and unless you treat it differently, you’ll find ways to get depressed over market fluctuations.
So, if you invest every two weeks or every month, think of these payments as a grocery purchase. Now, when you go grocery shopping, you probably have a fixed budget, or spend roughly the same amount each week. Because of that, what do you do? That’s right, you find sales and maximize how much your money will buy. The same should be said for your regular investment purchases. Every paycheck or each month, you have roughly the same amount going into your investment or retirement account. So, what should you do? Exactly, take advantage of sales, or low prices.
Think of it this way. If you need to buy toilet paper this week and notice it is on sale for about a 25% savings on a 4-pack, are you going to buy two packages knowing it probably won’t be on sale the next time you need to buy it, or do you buy just a single roll because the price has dropped? The answer is obvious, but unfortunately, it’s hard to think of purchasing investments in the same light, even though the same general principle applies.
Take Advantage of Your Accumulation Years
As Generation X and Y, we’re in a prime position to take advantage of what has happened in the markets both back in 2000-2002, and what’s happening right now. We’re in the accumulation phase of life, meaning we’re trying to stash away as much as possible while still working so that we’ll have a comfortable nest egg in 20-30 or more years. Market corrections like these are the equivalent of a year-end blowout on last year’s merchandise, and if you can buy and stock up now, you will get much more for your money.
This doesn’t mean you should throw caution to the wind and carelessly invest your money in anything, because you should still create a diversified portfolio and take advantage of what works best for your risk tolerance. But the last thing you want to do is save and invest even less just because the balance on your quarterly statement may go down. Since we’re generally talking about a few decades left until needing the money, the markets will recover, whether it’s this year, next year, or even a couple years from now. And if you stocked up when things were on sale, you’ll be thankful you did.
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Filed Under: Investing
About the Author: Jeremy Vohwinkle is a Chartered Retirement Planning Counselor® and spent a few years working as a financial planner. Today, he helps people make the most of their money by writing about personal finance here and elsewhere on the web. Jeremy is also Coach at Adaptu and a regular contributor for other publications such as Intuit, and American Express. Be sure to follow Jeremy on Twitter or Google+.