If you are holding an investment portfolio of , bonds, mutual funds and ETFs then you don’t need me to tell you that the markets have been quite bumpy lately.  Furthermore, there are no clear signs that equity market volatility is going to let up in the foreseeable future.  Naturally, this forces individual investors to question their tactics or even their entire approach to investment management (and the value of their financial advisor).

Here are questions I am asking myself:

  • Is my current investment strategy wealth creating?
  • Is my protected or am I am risking my hard-earned wealth?
  • Should I keep investing in - stocks?
  • The S&P 500 has returned approximately 1% in the last 10 years, how can I reach my financial goals with another 10 years of negative returns once I account for inflation?
  • My tax advantaged 401k, Traditional and Roth IRAs and my children’s 529 college savings plans have taken a beating, what do I do now?
  • Is -- ?  And if so, what’s my new approach to investing?

These are tough questions and there are no easy answers.   And anyone who tells you that they have the answer, is lying.  No one can predict the future and no one can guarantee returns in the equity markets, or most likely any market.

Dollar cost averaging is the technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price.   By doing so, more shares are purchased when prices are low and fewer shares are purchased when prices are high.

What to consider and what can you actually control

One of the main underlying themes in the questions list above is:  “Should I be a buy-and-hold investor?”

My answer:  “YES”. 

Why?  4 Main reasons:

  1. I am not a professional investor, I have a career and a life and I simply don’t have the time (or desire) to be a “trader”.   When I say “trader” I mean a short-term investor, someone who can move in and out of securities in quickly in hopes of timing short-term price movements to generate capital gains.
  2. Over 50% of stock pickers and actively managed funds do not beat the market.  These fund managers and traders are professionals, this is there entire job and they can’t do it.  Why would I believe that I can outperform these guys in my spare time?
  3. Short-term trading increases investment expenses and creates an undue tax burden in taxable accounts.   If I make a short-term gain (meaning I held the stock less than 1-year) then two things happen: 1) I have to pay a brokerage fee for the sale of the stock and 2) I pay a higher short-term tax rate on the capital gains.  In my view, neither is attractive.
  4. A Buy-and-hold approach still provides me with the flexibility I need to management my risk.   Just because I am going to “hold”, I still have a lot of control over when and how I “buy”.

Also, keep in mind, when I say “manage my risk”, this does not imply that I am able to create a portfolio that always performs well.  It just means that I can construct a portfolio and hold enough cash so that I can sleep at night.   This being said, here is what we can do  1) use historical information as a guide and to help us make rational decisions 2) save more, invest more and best position our portfolios for success.   Best positioning does not guarantee success, it simply improves our odds of success.

Dollar Cost Averaging & Buy and Hold Investing

When I look at most people’s investment portfolio a large percentage of overall equities is allocated to large capitalization, blue chip stocks such as IBM, Coca Cola or General Electric.  And rightfully so; these larger companies have stood the test of time, they pay dividends and are generally safer investments in terms of both price volatility and the relatively low probability that the company will go bankrupt tomorrow.

However, most of us hold investments in these large capitalization companies through mutual funds or ETFs that track the S&P 500 Index or Dow Jones Industrial Average (DOW).  This is because it is easier to buy shares of a fund then to buy shares in each of the individual companies that are components of the index.

Investing a lump sum amount 10 years ago in a fund that tracks the performance of the S&P 500 index would have yielded a disappointing return of approximately 1%; not even enough to cover the rate of inflation.  However, if you were to use a dollar-cost-averaging approach investing equal amounts on a weekly, bi-weekly or monthly basis your investment would have yielded a return of  2.41%, 2.26% and 2.44% respectively.

These 10-year returns certainly do not get me excited about a buy-and-hold investment strategy or a dollar-cost-averaging approach.

Use Volatility As Our Guide

The chart below shows S&P 500 Index pricing and volatility over the past 10 years.  The blue line represents the price, which is listed on the left axis and the red line represents volatility, which is listed on the right hand axis.  Volatility is measured over rolling 5-day periods.  As you can see, price and volatility tend to have an inverse relationship; e.g. when volatility increases prices tend to decline.

S&P 500 Index & Volatility 2001 to 2011

S&P 500 Index & Volatility 2001 to 2011

An investment approach to consider is a combination of lump sum investing and dollar cost averaging.   For example, If you were to take $100,000 and invest half, $50,000 over the last ten years in the S&P 500 Index through monthly dollar cost averaging ($396.83 per month) and then invested 5 lump sum amounts ($10,000 each) on 5 of the most volatile days over the lat 10 years, your total return would have improved to apprxomitely 13.99%.   In my example I assumed that I was not able to “call the peak” of the volatility and therefore I choose the 5th most volatile day in each of the peak volatility run-ups.

For example:  One of the purchases in my study was on 10/14/2008 with a measured volatility of 111% over a 5-day period.  However, this was not the most volatile day in the series of very volatile days during that time frame.  I used the 5th most volatile day since it is unlikely I would be able to hit it perfectly.

Date Volatility Price
10/13/2008 119%  1,003.35
10/14/2008 111%     998.01 BUY
10/15/2008 130%     907.84
10/16/2008 120%     946.43
10/17/2008 120%     940.55

Here are the days that I bought $10,000 lump sums in my study:

Date Volatility Price
7/25/2002 62%        838.68
10/14/2008 111%        998.01
11/26/2008 86%        887.68
3/25/2009 61%        813.88
8/9/2011 72%      1,172.53

Although a 13.99% return over 10 years is nothing to write home about, it is certainly much better than 1% return via lump sum investing or ~2% through straight dollar cost averaging. I like the combination approach and I continue to be a buy-and-hold investor.

What’s you investment approach these days?  Are you a buy and hold investor or a trader?

Related External Links

Related posts:

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  9 Responses to “Blue Chip Stocks To Build Net Worth or Is Dollar Cost Averaging Dead?”

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  2. Just saw your comment over at World of Finance! Wish I would have read this back in December!

  3. very impressive post! we are slowly moving into stocks right now so i think this is ahead for our time, but i’m definitely interested in learning more!

    • Thanks! Equities are a very important part of any portfolio, but I must admit that sometimes the volatility is hard on the mind. I just keep saving and investing knowing that I have 30 years before I need to money. Anything I need sooner I keep in less risky assets like cash or short-term bonds.

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  4. Since ‘volatility’ has often meant ‘massive down day’ lately – instead of an epic struggle ending on the upside, you’d definitely be killing it with your purchases. I sort of do this now – I only get interested in buying when my portfolio is “flashing red”, haha.

    Taking the Black Friday mindset to the markets? Priceless!

    • I try to buy in bulk when people are scared and the markets are dislocated. But I think it is important to buy regularly as well just because my lump sum purchases will not always work out to be the lowest price on a relative basis. Sort of a way to keep me from doing too much damage by making my own buy decisions

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