Manage Investment Volatility with Dollar Cost Averaging
By Jane Young
We are experiencing unprecedented volatility in the stock market due to COVID-19. The S&P 500 dropped 33.9 percent on February 19th from a high of 3386.15 down to 2237.40 on March 23rd. As the federal government approved trillions of dollars in stimulus money and the number of cases started decreasing, the S&P 500 has recovered about 55 percent of this loss with an increase of 28 percent from the low on March 23rd to 3863.70 in mid-May. Although we have seen significant improvements and the country is beginning to re-open, stock market volatility is far from over.
Most financial experts agree that current stock market levels do not reflect the full economic impact the virus will have over the coming months. It is reasonable to assume we will see another downturn, but it is likely to be less severe than the previous drop. It is impossible to know when and by how much the market will drop. However, we can be confident that economic disruption caused by the virus will lead to tremendous volatility for the balance of the year.
Despite anticipated volatility, we will recover from this and better times lie ahead. It may take a while, but history has shown us that the economy and the stock market will recover and will reach new highs.
In times of tremendous economic turmoil, behavioral finance experts have found that investors are prone to react emotionally. There is a tendency to overact to a drop in the market by selling at the exact wrong time, when the market is low, and buy when the market is high out of fear from losing out. On the other hand, disciplined investors learn to control their emotions and maintain a long- term perspective.
One tool that can help you navigate a volatile market is dollar cost averaging. Dollar cost averaging is an unemotional way to invest in the stock market in a consistent manner, regardless of the market. It would be great if we could predict the stock market, but this is impossible. We need a way to invest with minimal risk, without trying to time the market. With dollar cost averaging, you systematically purchase a set amount or percentage in a stock, mutual fund, or ETF at regular intervals. When the market is low you buy more shares at a discount and when the market is high you buy fewer shares.Dollar cost averaging allows you to invest in the market while providing some protection against market fluctuations and downside risk. It is most effective for investors who have a long investment horizon, maintain a diversified portfolio, and want to minimize risk. It is less risky that trying to time the market with a single lump sum purchase. However, under some market conditions, investing gradually can result in a lower return. A reduction in risk rarely comes without a potential reduction in return.