Dollar Cost Averaging and Income Protection
Updated: Aug 3, 2020
Dollar Cost Averaging
With the Stock Market down almost 33% (at the time of writing this article) since the beginning of the year, the unfortunate truth is most people have lost significant funds. This means that for many families they will have to delay their retirement, take significantly less income, or go back to work.
With losses around, one term you will probably hear from an investment advisor is “Dollar Cost Averaging” (DCA). To make money in the stock market you want to buy low and sell high. This isn’t new information. Ideally and historically the Stock Market generally trends upwards netting you growth which is how you make money. However there are times (such as now) when the stock market makes a decline; which is precisely the time when DCA “works best”. Because the stocks are lower in price now than when you originally purchased them you can buy more to bring your “dollar cost average” down.
For example, let’s say you originally purchase a stock of XYZ company. 100 shares for $10ea = $1,000. Down the road that stock suffers and the price goes down to $5ea. If you were to buy another 100 shares it will now only cost you $500, so you have 200 shares with total cost of $1,500 which on average costs you $7.50. So, now, instead of needing the stock to reach $10 to become whole, you only need it to reach $7.50, which means if it reaches the full $10, you’ve made money.
While dollar cost averaging is a viable strategy to help minimize/recoup losses, there is a big flaw in this thinking. That flaw is that you aren’t making any money on your original investment until you are back to whole. You are only making money on the new money you are putting in. This is its biggest disadvantage. That is why I prefer to use indexing strategies.
While it is true, with indexed strategies you have less opportunity for growth, but they have the trump card since you are guaranteed to never lose any money. Therefore, you never have to wait for the market to rebound to “get back to whole”. Instead, you are always making money. Let’s look at a basic indexing strategy with how the stock market works. With this strategy you will receive a return based on the market but it will never exceed 9%, and you are guaranteed to never lose a dime. In the chart below, the blue columns are assuming a $10,000/yr annual contributions (to simulate DCA strategy), while the green column is lump sum investing.
With indexing, while everyone else is rebounding trying to become whole, you are gathering that huge upside for even more growth! Let me ask you, which side of the chart would you rather be on? Protecting Yourself from Disaster Unfortunately, protecting yourself is a priority that will never go away. In fact, it becomes increasingly important each year as there are more things than ever before to protect yourself from. The lack of preparation from families across the globe has made this abundantly clear. While there are many things to protect yourself from, today we are going to be focusing on financial protection. More specifically, we will be talking about protecting yourself from loss of Income.
The first of these protections is protecting yourself and your family from a loss of income. There is no doubt that someone’s ability to generate an income is their biggest asset. The three biggest culprits that take away someone’s ability to produce an income: Death, disability and job loss. According to a survey by bankruptcy companies, 78% of bankruptcies are caused by a loss of income. In my opinion, that is 78% too high, since there are simple things that families can do to prevent this from happening. Death is hard to predict and has terrible consequences both financially and emotionally. Many people don’t like to plan for this as it is a sad topic, and no one wants to think about themselves dying.
The second one is Disability (short and long term). Most people ignore this as they think that they will be protected from worker’s compensation or SS Disability, but that is just not the case. Worker’s compensation only protects you if you are hurt on the job. SS Disability can be hard to qualify for and could take 2 years or more before it kicks in.
The last major cause of income loss is job loss. This is one I don’t really talk about much since it rarely happens but people lose their jobs for a variety of reasons. From being laid off, to having to care for loved ones, and company collapse. Companies collapsing usually only happen in severe economic conditions such as the Great Depression, the Great Recession of 2008, and 2020’s Corona Virus.
There are three great tools you can use to protect yourself from these things. The first is disability insurance (DI). There are two types of disability insurance (long term and short term). This insurance is low cost and can be used to replace your income for a preset amount of time in the event that you cannot perform the functions of your job. It is important to note that you do not have to be permanently disabled to qualify. The other good news, is that it doesn’t matter what caused your inability to work (so long as it wasn’t criminal activity). If you are disabled and can’t do your job, the insurance will pay out. The second thing you can use to protect yourself is an emergency fund. I recommend 3-6 months income. Too many people resort to using credit cards which just creates a snowballing debt problem that becomes hard to get out of. However, if you had access to a fund of money that you can use to take care of all your expenses for 3-6 months, it makes you so much more flexible. Corona’s financial impact wouldn’t be a scary thing anymore. The last one is my favorite tool, Life insurance. Life insurance is the “Swiss Army Knife” of financial vehicles. It accomplishes so many great things. Life insurance when set up correctly, can replace an income from a loved one if they pass, can provide an emergency fund to draw from, and can provide extra funds in serious illnesses. Additionally, if you don’t have to use it, (or you repay what you use) you can use it to fund a college education, or generate a tax-free income in retirement!
I don’t want any of my friends, neighbors or loved ones to suffer from one of these things, when there are easily preventable measures you can take. Please give me a call today so I can help you craft a plan that will best protect you and your family.