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Here’s what I tell them.
First, no one knows how stocks will do over the next year. So if investors are waiting for a bigger pullback, they will probably never get back in. For instance, in 2011 stocks fell by nearly 20 percent from their high, so why didn’t they jump in then? Clients respond that they didn’t at that time because they were waiting for a larger decline. Unfortunately for that strategy, the market didn’t decline further but instead quickly recovered, causing them to miss out on the bull over the next several years.
Today, investors might have other reasons for their procrastination, like waiting to see how the new White House administration does, or what happens with North Korea. Yet even if those uncertainties go away, others will take their place and investor paralysis will likely continue.
Trying to time the market is a loser’s game. If it’s risk investors are trying to avoid, I point out that leaving money in cash is perhaps the biggest risk of all, since it will lose spending power to inflation. Stocks are the best chance to earn a return greater than inflation.
Once their cold feet for the market have warmed up, clients will ask whether they should invest all at once or over time through a method like dollar cost averaging. DCA is buying a fixed amount over set periods, such as $1,000 in a stock index fund, say, each month or each quarter over the next 24 months.
Based on history, the mathematical answer is clearly to do it all at once. That’s because, in the very long run, stocks do better than bonds or cash, so buying them now gives you better odds. However, I’ll remind them that we are emotional beings, not mathematical ones. If they buy all the stock today and tomorrow ends up being the worst day in the history of the market, they will be unlikely to stay.
Thus, if investors buy using DCA, they at least diversify themselves emotionally from thinking they aren’t picking the worst time to get back into the market. That doesn’t lessen the risk any, however, since you can buy stocks over the next 24 months (or any period you use for DCA) with the market going up, only to have it plunge right after you got to your full target allocation. In that scenario, you’d lose more than if you had just taken the plunge and bought all at once, since your later purchases would have been at a higher price.