How would you like to save money? When you think about the best way to save
, our advice is to look for a method that allows you to do it effortlessly each month.
Can you imagine something similar for your investments?The truth is that this also exists and is called periodic investment.
This investment strategy is very simple: it involves investing the same amount of money every month, no matter what the market is doing. That is the essence of this model, the technical name of which is Dollar Cost Averaging or DCA.
To set it up you only need to do two things:
From that point on, all you have to do is schedule your investment, which can be as easy as planning a regular transfer every month on the same day of the month (better at the beginning, which is when income is typically received).
This is how you turn your investment into just another bill to pay, just like rent or electricity, and ensure that you invest every month, no matter what, without worrying about it.
Why periodic investment works: the power of averaging
This investment model has advantages and basically works for two reasons.
The first is that most people have more capacity to save and invest than they have money saved up for this purpose. This means that this strategy suits the financial situation of a large part of the population.
The second is that the general trend of the markets is upward, as we explained in an article on the importance of the term of an investment. What does this mean? On the one hand, the risk of loss decreases as the time you invest for increases, and on the other hand, the stock market tends to rise over the long term.
These two factors make periodic investment a suitable approach for the long-term investor, and you can apply it in two different ways.
The first is the most complicated and the furthest from the DCA philosophy. It consists of looking for the best time to invest each month. In this scenario, you know how much you are going to invest, but not when, and you play with the days of the month to find the best time to do it.
The second is the one that really reflects the DCA philosophy and also the one that will allow you to automate the periodic investment process. It consists of investing the same amount on the same day each month, without watching the market.
As you invest every month and do it automatically, there will be times when you will buy at a higher price, when the market is buoyant, and times when you will buy at a lower price, when the market is falling. In the end, what you will do is invest at an average price in terms of the market, which is what you should be interested in if you are investing for the long term.
To help you understand this better, let’s look at a practical example applied to investment funds. Imagine that you invest 200 euros a month in an investment fund that performs as follows:
- Month 1. The value of each unit is 50 euros. You buy 4 shares.
- Month 2. The value of each unit rises to 100 euros. You buy 2 shares.
- Month 3. The value of each unit returns to 50 euros. You buy 4 shares.
- Month 4. The value of each unit drops to 25 euros. You buy 8 shares.
- Month 5. The value of each unit remains at 50 euros. You buy 4 shares.
At the end of this five-month period you will have invested 1,000 euros out of your own pocket, and in total you will have 22 shares which, at 50 euros each, will add up to 1,100 euros, i.e. you will have made a 10% profit.
Advantages of periodic investment
Now that you know how periodic investment works, let’s take a look at its specific advantages as an investment model.
- It is convenient and easy to implement. In fact, you can automate the whole process if you invest in an investment fund portfolio, a Unit Linked plan, a PIAS or a robo-advisor, for example.
- You eliminate the stress of having to make money and investment decisions every month. You know that you are investing every month and buying at the average price.
- You reduce the risk compared to investing all your savings at once, although we’ll talk more about that later.
- You take advantage of the power of compound interest because you reinvest the profit generated by your investment and add the contributions you make each year.
DCA is a good strategy if you are investing for the long term. For it to really work, you must understand that there will be downturns as well as upturns, but that if you maintain your regular investment, you will eventually buy at the average market price. And in terms of more than 20 years, what has happened along the way will matter little to you if you have averaged it all out.
But if you have money, isn’t it better to invest it all at once?
As opposed to investing periodically, you have the option of investing all at once, through the lump sum method. Which of the two is more profitable?
Different studies show that investing all at once offers better results in the long run because when you invest, the time you invest for counts more than the specific moment when you invest. However, the studies do not tell the whole story.
Investing all at once means taking on a little more risk if, right after doing so, the market falls, and it can also generate more anxiety and stress. So which one should you choose? In this article we analyze the question in depth: Is it better to invest all at once or a little at a time?