There is a sentiment in the investment business that the stock market is the only store in the world where people run out of, instead of into, when things go on sale. An interesting and effective analogy.
The practice of investing can be nerve wracking for many people while others take market swings in stride or view as opportunities. Hard as they are to accept sometimes, periodic corrections and contractions are necessary. It is the very nature of the market.
Investor fear and worry triggered during market corrections and contractions can overshadow the investment opportunities they bring with them. On the other hand, investment professionals often welcome periodic corrections as a sign of overinflated markets normalizing and bringing about purchase opportunities.
Despite the role market corrections and contractions play, one thing remains constant: they can wreak havoc on investor psyche.
One way investors can reap the benefits of volatile markets, corrections and contractions is by employing a periodic investment purchase strategy most commonly known as dollar cost averaging.
Dollar cost averaging is a simple investment strategy that builds wealth in volatile markets. You systematically invest regular amounts at regular intervals (i.e weekly, monthly). The amount and interval you choose is based on your budget and what suits you. You can use any combination of investment amount and interval that will work for you. For example, you may choose to invest $100 per week, or $500 per month. The key is to keep it consistent and stick to it in a disciplined manner.
Markets move up and down daily and the amount of investment you are purchasing on any given day is often expressed by the purchase of units or shares of the investment. When the market is up (higher value = more expensive) your contribution amount will purchase fewer units or shares. When the market is down (lower value = less expensive) your same contribution amount will be able to purchase more units or shares. As a result, in market downturns, you are purchasing your investments at a lower price. Remember the classic buy low adage.
Market drops provide an advantage to the investor when they are employing this strategy. This periodic purchasing process takes advantage of fluctuating unit prices. The greater the market volatility the better the dollar cost averaging system works. This is a strategy that celebrates the swing of a volatile market.
Consider this scenario: let’s say the market drops 10% and an investor with $100,000 invested now has a market value of $90,000. This investor might experience some anxiety due to the drop in their investment value.
On the other hand, this downturn is going to get some investors excited because they see the investments as being available at a discount giving them the opportunity to purchase at lower prices in anticipation of the market recovery.
Although two individual investors may feel different emotions surrounding a market contraction, it remains a good idea for both investors to consider strategically purchasing investments during the market displacement to amplify returns upon the rebound if they have the ability to do so.
It is important to not let the emotion of fear override the potential opportunity. Even small incremental investments using dollar cost averaging to optimize lower prices can make a difference in the long run of a portfolio and remains a viable volatile market investment strategy.
Stephanie Farrow, BA., Certified Financial Planner, Stephanie has over 29 years' experience in the financial services industry, a diploma in Financial Planning from the Canadian Institute of Financial Planning and Certified Financial Planner designation. Stephanie has been writing a financial column for local business magazine Elgin This Month/This Month in Elgin since 2010. Stephanie and her husband own Farrow Financial Services Inc. About our Farrow Financial Team.