Alexander Wissel, Editor in Chief, Investment U
We get many interesting reader comments here at Investment U. We see our fair share of positive and not-so-positive comments.
Recently our article on dollar cost averaging elicited a host of responses that questioned why we are favoring using this strategy…
“Dollar averaging is a technique promoted by institutions to keep people invested long-term without deliberately managing their investment.”
And the reader is absolutely right about that. Mutual fund companies would love nothing more for investors to invest blindly – either through retail brokerage or their 401ks – their goal is for investors to keep their money with them as long as possible.
More than a few of use have sat behind the “mutual fund service desk” giving the company line to a customer who’s lost a substantial sum in their mutual funds. If it’s not a retirement account the correct answer should be “yes, sell those shares, take a tax loss and buy back in after 30 days if you really believe in the fund.”
Unfortunately, the conversation doesn’t go like that. It starts with something like “…mutual funds are a long-term investment and shouldn’t be traded as a short-term investment. Stay invested in this fund and trust that the fund will come back, and that long-term results will etc., etc.”
Mutual funds are in the business to hold money, not let their shareholders trade. It’s why we recommend ETFs. They give investors the same diversification advantages without the hassles of mutual fund fees, expenses, and bureaucracy.
So we agreed with the first point, but we strongly disagree with the next few.
Investment U does not “favor” investing without a disciplined plan for selling. It’s why we use trailing stops. Trailing stops are a disciplined “sell strategy” for locking in gains and preventing small losses from becoming big ones. You can read more about them here.
The next point really stuck out to us as needing some review.
“Anyone who wants to make serious money would NEVER use dollar averaging.”
Dollar cost averaging is a strategy for building up a position in a stock, mutual fund, index, ETF or any other investment. It allows an investor to limit their risk of buying in at the peak for whatever time period they invest over.
However, you could also use the same strategy to leverage out of a position. As opposed to selling in one large sum, you could sell in smaller amounts (the way money managers do). It would lower the risk that you sold out at the wrong time.
We also received a comment on the transaction costs involved with multiple smaller transactions. There are brokerages like Sharebuilder.com that allow you to purchase on a consistent basis at a reduced commission – $4 or lower depending upon your plan.
Hope this helps clarify some of the misunderstandings surrounding dollar cost averaging and its benefits and downsides. Our goal at Investment U is to give you impartial, no-nonsense advice on how to build long-lasting wealth.
- Building Wealth: Using The Dollar Cost Averaging Strategy
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