Section IV - Lesson 7
Employing Your Ideal Timing Strategy
The ideal timing strategy for investing your money is dollar cost averaging, of course, as we’ve already discussed at length. But by now you’ve probably gained a deeper understanding as to why this is so, than you may have had earlier in your reading.
A 35-year-old person will make 360 regular monthly purchases to his two accounts over the 30-year period before turning 65. These monthly dollar amounts will most likely increase from year to year due to salary raises, but they'll ordinarily prove to be constant and regular and without peaks and valleys.
As the market appreciates over this period, at an average annual rate of 10.5%, it's extremely unlikely that any major portion of this person’s investment fund will be bought at unusually high or low prices. Indeed, it’s most likely that the bulk of this person’s investment accounts will be purchased at about the market average for the 30-year period, which will be considerably lower than where the market will be at the end of the period.
If this same person now begins monthly withdrawals from these accounts at age 65 and makes 240 roughly equivalent or gradually increasing monthly sales over the 20-year period to age 85, as the market continues to appreciate at an average rate of 10.5%, it’s most likely that these sales will be at much higher average prices than the purchases of 25 years earlier.
If you understand this scenario at not only an intellectual, but also an emotional level, you’ll know why dollar cost averaging, in connection with diversification and a long-term investment program, is the perfect way to time the market. The technique is literally foolproof, and lends itself perfectly to a long-term program of buying market index funds. Why take a chance on any other way to time the market?
Let's spend some time talking about a problem that you might encounter with your regular money account that was not a factor with your 401k. Let's talk about the perils of investing a lump sum of money, such as a windfall, which is a type of market timing situation that should be avoided in any way possible. The bigger the lump sum of money, by comparison to the usual monthly investment, the greater the urgency to avoid the timing problem.
The danger of lump sum investing, of course, is that you may be purchasing a major chunk of your total portfolio at or near a short term market high, which would do serious and unnecessary damage to the otherwise favorable average cost of your overall investment account. Instead of getting the most for your money, as you do with dollar cost averaging, you may be getting the least, and getting it on the major portion of your holdings.
The recipient of a windfall is faced with a dilemma, in that the best time, usually, to invest money is when you get it. After all, “early money” earns the most, and the sooner you put money to work, the better. But you can't take the chance of clobbering your average cost. Granted, you have a happy problem, but a problem nonetheless.
Assume that you have about $50,000 accumulated in your regular money account after several years of contributions, and you suddenly are presented with a windfall. You’ve just inherited $100,000 that you want to add to your regular account.
Your natural inclination would be to get the money working just as soon as possible, but simply making a one-time lump-sum purchase of additional shares of your S&P 500 Index fund would not be a good idea. Large sums of extra money must be invested with special care.
For all you know the stock market may be approaching a near-term “top” for the next few years, and there’s never any way of knowing this except after the fact, when it’s much too late to benefit from this information. Were you to purchase the full $100,000 at these high levels, two-thirds of your holdings would carry this high cost, and your entire investment account would be “in the red” until the market recovers.
A better approach to the problem is to convert a large lump sum into a series of smaller payments, because trying to “time” the market for a $100,000 purchase is much too risky when you only have $50,000 in your account to begin with. If you already had $5,000,000 in your account, adding $100,000 would pose no problem whatsoever. It’s a question of how much impact your new purchase will have on your existing accumulation.
In Lessons 8 and 9, which follow, we'll suggest some techniques that will help you deal with such lump sums.
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