This is an appropriate time to write an article on the impending doom of the economy. The tone is likely going to be a bit harsh as talking about this subject is beyond annoying for us if you have been doing this for 60-80+ hours a week for multiple years…. but it needs to be done.
Back in 2007 the market was roaring due to a real estate bubble and everyone expected the bull market run to continue. Fast forward to March 2009 and everyone you knew was ready to buy guns and write off the entire equities market as a sustainable investment prospect. Fast forward again… and the S&P 500 is at all time highs of 1,700+. Needless to say the herd is always wrong.
What is everyone else doing? It’s probably a bad idea.
With that said lets go ahead and explain why you should always ignore the doomsday prophets, a handful of them are intelligent (Roubini for example) but the vast majority do not understand investing. This is going to be a rudimentary introduction to dollar cost averaging.
Buying the S&P 500 Monthly: For this example lets use the 2007 to 2013 time frame (roughly six years – 5.833 years to be exact). To make the example difficult, we are going to assume that you started purchasing shares at the peak of the last bull market. On June 1, 2007 the market was at 1,536, in addition we will assume that you survived until the market roughly broke even on March 1, 2013 at 1,518. This is terrible market timing, you began investing at the peak of the market. With that said here are all of the assumptions laid out, again this is assuming your timing was terrible and you bought at the peak and quit at break even.
– You buy $1,000 of S&P 500 (Simply use the ticker SPY) on June 1, 2007
– You buy $1,000 worth of S&P 500 the first trading day of each month after you receive your paycheck
– You never sell
– You never reinvest dividends
With that here is the chart of SPY.
Capital Appreciation: The chart doesn’t look that great. However this does not take into account dollar cost averaging. Over the next 70 months you are purchasing $1,000 in shares so lets go ahead and see how that works out.
– You spent $70K
– You obtain 583.5 shares of SPY over the course of 7 months
– 583.5 Shares * 151.82 = $88,585
You made money. Below is a chart of exactly why this works, the answer is relatively simple: consistent buying patterns allow you to lower the average cost per share.
Dividends: We’re not done yet. We haven’t accounted for the dividends you’ve accumulated over the past 5.833 years. Lets go ahead and include them. We don’t want you to spend your time running these numbers so here is the table for you.
There you have it over the last five years you have accumulated ~$4,250 from dividend payments and we will go ahead and assume that you have not reinvested this money, it is sitting collecting dust in a savings account or under your mattress.
Final Calculation: Here is the final break down. You begin investing in the worst time possible, late 2007 and you purchased $1,000 worth of SPY for 70 months giving you a net investment of $70,000. In return if you decided to quit investing when the market was near break even you would have $92,837.
If we use a CAGR your total return was (($92,837/$70,000)^(1/5.8333))-1…. 5% annualized return. 7% returns should no longer seem impossible particularly given this example.
Concluding Thoughts: Now that the numbers are laid out, why exactly do people continue to lose money? They are unable to control their emotions. They attempt to out trade algorithms (will never be successful), they live in fear of a possible world collapse (check their bank accounts they are likely broke) and they have never run the numbers.
While this post is much more blunt you’ll be happy to know our next will be more upbeat. With that said, remember this, if someone believes the world is going to end, 9 times out of 10, their life has already ended. They chose to live in the moment and refused to put in the work.
Update 2017: The S&P 500 is now at new record highs ~2,400.
What you just said is what the great Benjamin Graham preached way before Buffet even set foot on a trading floor. Following what others do means buying stocks that are overpriced, overpriced means that the ball with only roll uphill so much, until it rolls back down. Great stuff!
Correct, this is for beginners. We got several emails about how to invest and the answer is always the same, consistently buy.
Most people will look at the chart and simply say “well the market never gives you returns”.
Now you have the numbers to prove that it works, in the worst recession in the past 20 years.
Don’t listen to the talking head on tv.. Do the hard work and research.
Another awesome personal finance post!
Where do you see the current bubble topping out, or do you believe the current bull market is sustainable?
We have made no comment about a bull or bear market.
The point of the article is to avoid thinking in terms of bull, bear, bubble, crash and run up. Instead you should focus on 1) reinvestment, 2) consistent contributions, 3) ignoring the media your friends and anyone who believes they are an economist. We get many emails suggesting we buy xyz stock, we never respond.
It is mentally taxing to do as we are suggesting. Ignore everyone.
Think about it like this, with the math above, if the market declined 29% in a day and you invested that entire time… You would be at break even. That is actually incredible.
Great post, I tried to explain this back in March/April to my co-workers who said you can’t make money in the market.
I’ll just send them to this post since it lays out the numbers for them in plain English.
How do you contribute your bonus? Invest it all at once? – Actually, unless I missed it, an article on bonuses would be awesome!
Save your bonus (invest).
You more likely than not you blow through most of your salary living in a high expense city, but always save/keep your bonus money.
Unless you’re an analyst you’re paid at year end so numbers have yet to come out yet. Analyst numbers were flat to very slightly up from last year. (~$55K, ~$70K, ~$90K)
Just a correction: Your “5.833 years” should be changed to days. Appears twice.
Great and interesting article – but just delete my comment after the corrections 🙂
The years is correct. 2007 to 2013 is roughly 6 years.
If you’re making 7% returns in 6 days… well…
I have a quick question.
I understand what you have said above and if I was saving $2k of my salary each month I could invest that.
But what happens when you have a lump sum of money ($50k) that is just sitting in your bank? what would you do in that situation?
Do you just increase your investment to $4k/mo until that lump some is fully invested over a period of time or do you simply invest it all at once?
Thanks in advance.
If you plan on investing for longer than 20+ years it doesn’t matter. You can do a lump sum because $50K won’t move the market at all.
Overall, it really won’t make a difference. If you do $4K a month for a year. Or do it all now. Both options put $50K into the market in a single year.
Do what you feel most comfortable with! Dollar cost averaging is a long-term strategy.
Excellent thanks for the fast reply!
No problem
Why aren’t we reinvesting the dividends?
You should, we just made the math simple.
Situation:
I have approximately £15,000 in various saving accounts giving me a puny return on my money. Since I start a graduate scheme (tier 4) in February that pays a pretty average starting salary of £35,000 my plan was to save for a 18-24 months and use the money to place a deposit on a house.
Reading this post has completely changed my mind frame. My new plan is to dollar cost average £1,000 per month until I start my job and then £1,600 once I start my job, into VUSA. After 18-24 months I would then consider buying a house.
Question:
Is this a long enough time frame to make returns between 5-7%? Taking emotion out of the decision I would say no, but I think the returns would still be better than an average saving account. Even if returns were flat, I could just keep DCA until the market picks up again. What are your thoughts?
Love the blog. Thanks.
No. If you are gong to buy a home you should not risk the money.
Put it into a guaranteed return (certificate of deposit)
If the market goes down 5% and you needed the money within a year you simply wasted your time.
Dollar cost averaging is a 30+ year strategy not a 1.5-2 year strategy.
Thanks. Onto my next point. Is buying a house at such a young age a good idea (22-24 years old)? Logic tells me I should use my money to create a scalable start alongside my career.
Already covered. No, no home purchase until 30 at earliest (you must be willing to live there for 10+ years)
If you ask questions that have already been answered we will begin deleting them.
Yes business + career is 100000000x more important than a home.
Ironically, a cursory skim through Google results shows Roubini is consistently bearish on crypto…