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Taking the emotion out of investing with dollar cost averaging

May 15, 2015 at 8:46PM

Q: My partner and I are both high-income professionals in our early 40s without kids. We maximize our 401(k) and IRA contributions each year. Over the years we have defaulted to depositing our earnings in savings accounts, the result being that we now have well over $1 million in savings and checking accounts. We would like to invest this, but the timing seems unfavorable. Should we start investing monthly anyway, on a gradual basis? Invest in other vehicles? Wait and do nothing?

A: I would spend time thinking through what you want to do with your life, your careers and your jobs. Your vision of the good life is what should determine your investment strategy.

For example, let's say one or both of you want to start a business or a nonprofit. In that case, you might want to keep your money in safe savings as a hedge against the risk of entrepreneurship. Perhaps one of you wants to go back to school. Again, you would keep a large chunk of money handy to get the degree without debt.

But maybe you love your current work. In that case, you can afford to take greater financial risks than the typical household.

That said, there is rarely a good time to get into the market. It always seems that stocks are overvalued or they're spiraling sharply lower. Some historic market measures provide guidance about when market valuations are particularly high and when securities are definitely undervalued, but the timing of a turn in the market is always uncertain. Only with the crystal clear benefit of hindsight do we mutter how could so many people be so foolish to pile into a market or so scared to not see value.

Prof. Jeremy Siegel of the Wharton School calculates that the compound average annual return on stocks adjusted for inflation has ranged between 6 and 7 percent. However, on average Lake Erie never freezes. Even a cursory glance at market history shows that securities fluctuate wildly.

In general, for anyone wanting to get into the market but unsure about the timing, a solid strategy is to set up a dollar cost averaging program. Dollar cost averaging means establishing a regular, automatic investment schedule, much like a 401(k). The advantage of dollar cost averaging for the long-term investor isn't financial. It's psychological. Dollar cost averaging takes emotion— fear and greed — out of the investing equation.

Chris Farrell is senior economics contributor, Marketplace, and commentator, Minnesota Public Radio.

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