Dollar Cost Averaging (Detailed Explanation)

the way I see it you have two ways to invest one you can try to time the market or two you can just forget about trying to time the market and just invest consistently and automatically using dollar cost averaging in a previous video I talked about the pros and cons of trying to time the market and using actual historical data through the S&P 500 I made a spreadsheet that tells you how much money you would have ended up with if you had timed the market perfectly and bought in at all the right times after the three major market crashes in the last 30 years and I also tested to see how much money you would have ended up with if you hadn't tried to time the market at all so in that spreadsheet I projected what would have happened if you had invested $500 a month into the S&P 500 over a 31 year period using dollar cost averaging in other words you invested equal dollar amounts into the same index fund at the same time every single month and this was whether the market was going up or down then I compared that strategy to a market timing strategy where in an imaginary investor with psychic abilities timed his purchases with 100% accuracy what's super interesting is that the investor who invested using dollar cost averaging ended up with one million one hundred eighty three thousand two hundred twenty four dollars whereas the investor who timed to the market perfectly ended up with 1 million two hundred thirty-five thousand seven hundred sixty dollars in other words not a huge difference the dollar cost averaging investor ended up with only slightly less than the investor who times the market perfectly given that timing the market isn't even actually possible I would say that dollar cost averaging is a pretty good way to go unless of course you actually do have the ability to see the future in which case we need to talk but for now I'm just gonna assume that you aren't able to see the future and that you actually do want to learn about dollar cost averaging so in this video I'm going to explain what dollar cost averaging is and how it works I'll also talk about why dollar cost averaging is so effective and finally I'll show you how to actually do dollar cost averaging in your own portfolio so if that sounds good to you give this video a like and let's get right into it dollar cost averaging is a strategy where you invest the same dollar amount into the same stock or fund at regular intervals and this interval can be weekly bi-weekly monthly quarterly whatever interval you choose so let's say you decide to invest $500 into the S&P 500 on the first of every month that means you're buying $500 here here here here here here and here and so on and so forth every single month every time you buy you're getting in at varying levels of the market so the number of shares that you get for your 500 dollars will also vary when the S&P 500 is high your $500 gets you fewer shares and when the S&P 500 is low your 500 dollars will get you more shares do you see what's happening there when the market is high you buy less shares and when the market is low you end up buying more shares that is how dollar-cost averaging works it's kind of like when you're at the grocery store and you see that something is on sale you want to load up on it and then if something's more expensive you tend to buy less of it and ironically when it comes to the stock market most people end up doing the exact opposite right after a big drop in the market when it's actually the cheapest time to buy stocks most people don't buy it all and in fact they do the opposite they sell so we're all guilty of this as much as we like to think that we're rational human beings when it comes to our money we're actually more driven by our emotions so the number one reason why dollar cost averaging is so effective is because it protects us from our own emotions so this is a perfect segue into what I want to talk about next does dollar cost averaging actually work the short answer is yes it works starting in 1988 if you had invested $500 a month into the S&P 500 with dollar cost averaging you would have over 1 one eight million dollars today and out of that 1.1 eight million dollars only a hundred ninety two thousand dollars of that was money that you actually put in the rest of it all was stock market growth pretty crazy right you end up with way more money than you put in so yes I would say dollar cost averaging works but let's go even deeper shall we let's try to understand why it works so dollar cost averaging is effective for three reasons the first is that it takes emotions out of the equation and when it comes to investing you know your emotions are your worst enemy the best time to buy in the market is also gonna be the scariest time to buy so if you invest according to your emotions you'll end up just chasing the market and getting nowhere but with dollar cost averaging you invest like a robot no matter what and this results in your average entry price improving automatically over time the second reason why dollar cost averaging is so effective is that your money has no downtime in other words all your investable money is invested at all times instead of parking your money in a bank account while you're sitting out and waiting for a better time to buy all of your money is working for you in the stock market day in and day out and when your money is working for you in the stock market you're participating in all the dividends and all the growth that gets compounded over time people who instead decide not to do a dollar cost averaging and they would rather just sit on a bunch of cash until there's a better time to buy they might risk having their money just sit in a bank account earning nothing for a really long period and this ends up penalizing their returns over time because they're not collecting any dividends and they're not getting any growth while that money is parked in a bank account last but not least dollar cost averaging works because it's actually doable unlike a strategy that requires you to time the market perfectly dollar cost averaging is actually realistic anyone with any amount of time or knowledge has what it takes to implement a dollar cost averaging strategy your six your old cousin can do it my grandmother who doesn't even know how to turn on a computer can do it even my dog can do it if you're still not convinced about dollar-cost averaging check out this extreme example so back in 1989 there was a huge bubble in the Japanese stock market so in December of 1989 it peaked at around 40,000 and when that when the stock market bubble burst it crashed really hard let's say you were unlucky enough to buy right at the peak of the market then 30 years later you're still in the red you haven't made your losses back because the Japanese stock market still has yet to recover back to those levels scary I know however this is the cool part if you had followed a dollar cost averaging strategy jus