2020 has definitely been a wild ride so far for the United States. Let’s look at a few of the major news updates that have occurred over just the past few months:
- The COVID-19 virus entered and spread throughout the country.
- This triggered a business/economy shut down the likes of which has never occurred before.
- There was civil unrest across the country.
- There was a presidential election and one party is refusing to admit defeat.
If you are new to the world of investing, this might seem like the worst time to get started. The initial shutdown caused a record-setting decline in the stock market and it seems like every day there is more bad news related to COVID-19. Financially savvy people are definitely staying far away from the stock market. Or are they?
his article will examine why volatility is actually your friend if you own a 401(k) account.
What is Dollar-cost-averaging in a 401k?
Dollar-cost-averaging is an investing strategy that people will use to defend against market volatility. It is defined as a strategy where the investor divides up the total sum of money to be invested into equal parts and invests them one at a time during a set number of periods.
Some of the advantages of this strategy are:
- Minimizing risks that exist because of market volatility.
- There is a lower chance you will lose an entire lump sum of money because of a market decline.
- It helps remove emotion from the equation by putting your investing on a schedule.
For example, let’s say you have $5,000 to invest. However, you are nervous that the market will crash right after you invest your money. Instead of investing all $5,000 at once, you want to do it in a way that is a little safer. So, you implement dollar-cost-averaging and split the sum into 12 equal parts. Now you can invest this lump sum slowly throughout the course of the entire year. If the market declines at any point, your money will be protected since it is being invested over time.
This will protect you if you are buying stocks because you will be able to buy shares in one month when the share prices are up but you will also be buying shares when the prices take a dip.
NOTE: You can choose how you want to break up your investing (monthly, weekly, daily, etc.). There is no right or wrong answer, the idea is just to do it slowly over time.
One of the reasons that investors prefer dollar-cost-averaging is because it takes the guesswork out of the equation. You will not have to spend every day contemplating whether or not to buy or sell stocks and can avoid being influenced by daily news alerts.
Some financial gurus refer to this as “set it and forget it”. As in, set up an automated investment to execute each week/month and then you can focus your attention on other things.
The main takeaway from dollar-cost-averaging is that you do not want to end up on the list of people who have lost everything because they made one wrong decision. With a dollar-cost-averaging approach, you consistently build sustainable wealth while minimizing the risk.
Most importantly, you don’t need thousands of dollars to make dollar-cost-averaging work for you. You can start with as little as $100 or even $50 per month. The more important thing is to make sure you are putting money into the market consistently.
Biggest Stock Buying Opportunities in a 401k
Apart from just using dollar-cost-averaging, there is another reason why market volatility can actually be a good thing for your investments. To summarize why, we can remember the famous quote from Warren Buffet, “Be greedy when others are fearful, and fearful when others are greedy.” During 2020, investors have been fearful (for the most part).
Just like the financial crash of 2008, the beginning of 2020 saw one of the biggest stock market declines in a decade. Due to uncertainty around COVID-19, investors fearfully rushed to pull their money out of the market. However, if you were able to keep a level head, then this presented a great opportunity. Lower stock prices can sometimes just mean that that stock has gone temporarily “on sale”. In the case of this year, the stock market came roaring back and there was the potential to make a 40% return in just a few months.
Despite the swirling negativity and volatility that surrounds the stock market in times of economic uncertainty, these times usually present a great buying opportunity.
How to benefit from volatility with your 401k account
If the bulk of your investing is done through a 401(k) plan then you can still take advantage of this. Odds are that your 401(k) invests in a wide array of mutual funds. This means that you can simply invest more when it looks like your 401(k) is down
Now, if your 401k account shows you that the mutual funds you own are not performing well, it is important to remember that your money is not lost. Instead, your money is invested in the stocks that have declined in value. As soon as the price of these stocks rebound, your money will return.
You will not actually lose any money until you sell your investments because once you sell them you turn the loss real. Instead of contemplating selling when your 401(k) account takes a dip, you should get excited because it means there is an opportunity to increase my monthly contribution and build even wealth.
When it comes to investing in your 401(k), you can treat it the same way as dollar-cost-averaging. By contributing monthly to your retirement account, you will basically be buying new shares of stock every month. Some months you will be buying more shares at a cheaper price when the stock prices are down while some months you may buy fewer shares when the prices are up.
High benefit with low risk
This process of steady and consistent investing has a proven track record of success. It will help you take advantage of low prices when stocks are down and also continue to benefit when stocks are up. If you want to get a higher benefit from the low stock prices, you can increase the monthly contributions and buy more shares for less.
The dollar-cost-averaging strategy is the most suitable for you if you want to take advantage of the volatile stock market to grow your 401k account.
We hope that you have found this article valuable to understanding why volatility is your friend if you own a 401(k) account!
About Kenneth Christian:
Kenneth has over 20 years experience as a financial advisor and wealth manager helping clients nearing retirement, in retirement, clients going through a transition, and working with business owners. He works with clients virtually all over the United States.