The Highs and Lows of Dollar-Cost Averaging
Investors who defer the same amount of money from their paycheck into a 401(k) plan at regular intervals are practicing dollar-cost averaging. By investing the same fixed dollar amount each time, the investor buys more shares when prices are low and fewer shares when prices rise.1 The long-term effect is that the average cost of each share purchased will be lower than the average share price.2
This strategy can work great when you are trying to accumulate assets for your retirement. But what happens when you withdraw from your investments for retirement income? While dollar-cost averaging reduces the risk of investing a lump sum of money when prices peak, it increases your risk of losing previous gains if you withdraw money when prices have dropped. If a retiree receives automatic systematic withdrawals for a fixed level of income, then in months when share prices drop, he or she will likely have to sell more shares to raise the needed money. Once those shares are sold, they never have the ability to recover lost gains.3
To create a more prudent income distribution plan, you may consider incorporating some solid, reliable income in your portfolio, in addition to Social Security benefits. This could mean government-backed bonds or an insurance-backed annuity.4 If you’d like to discuss how to position your assets to combine both guaranteed income and growth opportunity, please contact us.
It’s a good idea to develop multiple streams of retirement income. Ideally, you want to have the flexibility to stop and start withdrawals strategically from accounts that are performing well, giving others time to recoup paper losses.5 Also, maintain a healthy portion of assets in a liquid account to help pay for periodic expenses when you don’t want to tap your investments.
Another option is to be flexible with your retirement budget, such as having a Plan A budget and a Plan B budget. When the markets take a downturn, you can switch to budget B and downsize your expenses, perhaps by cutting out vacations, large purchases and eating out for a while. This shouldn’t be too hard given the way people have had to reign in their lifestyle throughout the past few months; you could call it your Pandemic Budget.6
Content prepared by Kara Stefan Communications.
1 James Chen. Investopedia. March 16, 2020. “Dollar Cost Averaging.” https://www.investopedia.com/terms/d/dollarcostaveraging.asp. Accessed July 10, 2020.
2 Dan Burrows. Kiplinger. April 17, 2020. “Dollar-Cost Averaging: How Does DCA Work, And Should You Do It?” https://www.kiplinger.com/article/investing/t052-c008-s001-dollar-cost-averaging-how-does-dca-work-should-you.html. Accessed July 10, 2020.
3 Matt Becker. The Simple Dollar. April 9, 2020. “The Truth About Dollar Cost Averaging.” https://www.thesimpledollar.com/save-money/the-truth-about-dollar-cost-averaging/. Accessed July 27, 2020.
4 Dennis Ho. The Street. July 2, 2020. “How to Use a Deferred Income Annuity to Avoid Running Out of Money in Retirement.” https://www.thestreet.com/retirement-daily/planning-living-retirement/how-to-use-a-deferred-income-annuity-to-avoid-running-out-of-money-in-retirement. Accessed July 10, 2020.
5 Jeff Rose. Forbes. Nov. 2, 2017. “5 Ways To Generate Different Sources Of Income.” https://www.forbes.com/sites/jrose/2017/11/02/different-sources-income/#42d46f7137bb. Accessed July 10, 2020.
6 Rebecca Moore. Plan Sponsor. June 22, 2020. “Clearing Up Confusion About Retirement Timing.” https://www.plansponsor.com/in-depth/clearing-confusion-retirement-timing/. Accessed July 10, 2020.
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