Index Dollar Cost Averaging Accumulating Wealth With Time

The broad U.S. indexes (specifically the S&P 500 index) have beaten all but a handful of mutual funds over almost any 10-year period. I have researched as many mutual funds and private broker managers as possible that have beaten the S&P consistently over the years and find no compelling reason why they might continue to do so in the future.

The major indexes are far more diversified than a typical mutual fund or basket of mutual funds.

Indexes also charge far lower annual fees than a vast majority of mutual funds.

You do not need to pay a broker, adviser, or financial planner to help you invest in this strategy while they collect big fees or commissions.

With all this taken into consideration, investing in a diversified mix of indexes may or may not make you money over the long or short term. It will certainly be volatile—too volatile for high net worth investors to risk. It will be scary at times to watch your account lose large percentages of money.

However, dollar cost averaging into indexes may offer the most viable answer as an additional growth generator for those still striving to become millionaires from their own efforts.

For those with a net worth of less than $1.5 million here is my answer to your question: "How and where should I invest my savings?"

As a nonqualified investor, until you get to the promised land of $1.5 million net worth or higher, dollar cost averaging is a great way to keep your emotions in check and hedge your bets.

The way to statistically stack the deck is to dollar cost average over a 10-to-15-year period.

Dollar cost averaging is investing a set percentage of your assets in a consistent way over a long period of time.

For instance, every January 1 and/or every July 1, you could continue to invest equal dollar amounts, or an equal percentage of your salary, to each current broad investment, whether they have gone up or down since your last investment period.

You can do this with a few good broad indexes, or even a basket of exchange-traded funds (ETFs). Just make sure you are well diversified in sectors and capitalization sizes.

If the market falls, you will be investing your next sum of money at lower prices and better valuations. It is as if you were able to turn back the clock to previous months or years.

If the market gains, you made money on the money you had invested.

To protect against a strong run-up in inflation, which is bad for both stocks and bonds, you may want to consider having some TIPS in your portfolio (inflation-adjusted bonds). Just be aware that while TIPS may limit the volatility somewhat, they could also limit the overall growth of the portfolio during a 10-year period.

Let's take an example of a dollar cost averaging approach:

If an individual had $200,000 to invest, and a steady or increasing working income yielding $50,000 of investable cash per year thereafter, I would consider investing $100,000 to begin, $100,000 six months to a year later, and $50,000 each year thereafter.

With a multiyear dollar cost average investment plan, if one can remain faithful to the plan even in the worst of times, the likelihood of profiting is high.

Dollar cost averaging combined with broad diversification provides the necessary tools for the nonqualified investor.

Here are some possible indexes to choose from:

1. Most of your assets should go into either or both of these two indexes (a minimum of 50 percent and a maximum of 90 percent between the two):

S&P 500

Wilshire 5000

Remember, within these two broad indexes are REITs, oil companies, gold and precious metal companies, and all the other current darlings being hyped by the financial media. You need not feel left out. You will be invested in the biggest winning, and losing, sectors every year.

2. 10 to 25 percent of your assets should be placed internationally:

Use a diversified international or global index, or a big international mutual fund, such as Oakmark Global I.

3. You might consider dollar cost averaging 0 to 20 percent of your assets into a combination of these:

Russell 2000 (these are small caps only and will be more volatile).



The combination of the Russell and NASDAQ should not exceed 20 percent in total.

4. You might consider dollar cost averaging 0 to 25 percent of your assets into any combination of these:

A REIT fund or REIT index, especially if you do not own your house. (REITs are real estate investment trusts.)

TIPS. Adding TIPS to your dollar cost average portfolio will reduce its growth potential. However, for those investors who want to reduce their short-term volatility, consider buying TIPS for 5 to 15 percent of your portfolio.

The goal would be to add to each of these investments on a consistent basis over at least a 10-year period.

Choose the mix according to your risk tolerance, not according to what indexes you think are going to perform better. Stay inside the percentage parameters I offered.

An aggressive mix would look like this:

25% S&P 500 index 25% Wilshire 5000 index 20% International 10% Russell 2000 10% NASDAQ (QQQQ) 10% Wilshire REIT index

A conservative mix would look like this:

30% S&P 500 index 30% Wilshire 5000 index 15% International 15% TIPS 10% REITs

Remember, we are not going for a 60/40 stock-to-bond ratio, or any other conservative type of traditional portfolio mix. We are going for growth and using dollar cost averaging to hedge our risk over a 10-year period or longer.

As you add money each year or semiannually, move toward rebalancing the percentages of each index or fund you initially chose.

I am also assuming you are not investing more than a few hundred thousand dollars in this strategy, even over time, since you would at some point likely qualify as a high net worth investor and would want to consider shifting a majority of your assets into Portfolio 2.

Lessons From The Intelligent Investor

Lessons From The Intelligent Investor

If you're like a lot of people watching the recession unfold, you have likely started to look at your finances under a microscope. Perhaps you have started saving the annual savings rate by people has started to recover a bit.

Get My Free Ebook

Post a comment