With the broad sell-off in stocks in the last two months of 2018, followed by gains in the early months of 2019, volatility has returned as a factor for investors to take into account. It’s been so long since the last bear market (2009) that some investors may need a refresher on dealing with volatility.
Dollar cost averaging
Imagine that you have $100,000 to invest today in the stock market. The trouble is, prices fluctuate from day to day, and you don’t want to buy at the “top” of the market. Your fear of loss may cause you to delay making the investment—but that same hesitation might cause you to miss out on price gains!
One approach to consider to get over the emotional hurdle is to spread your investment over time. For example, instead of investing the entire sum at once you might invest $25,000 each week for four weeks. This approach is called “dollar cost averaging” because equal dollar amounts are invested, which means that if prices go lower, more shares will be purchased. This may give a lower average price per share when prices are volatile. Here’s a simplified example.
Assume that XYZ company shares are selling for $200 today, so that $100,000 could buy 500 shares. Now say that the price falls to $180 in a week, to $175 the following week, then to $190, and rallies to $205. If you made a single lump sum purchase of 500 shares at the beginning, it would be worth $102,500 at the end of the period, a gain of $2,500.
With dollar cost averaging, you would buy 538.31 shares, rather than only 500. The average price per share falls from $200 to $185.76. In this example, when the share price rallies to $205, the gain from the investment is over $10,000, some four times higher than with the lump sum investment.
However, dollar cost investing certainly does not guarantee that the investor avoids a loss. What’s more, in a steadily rising market, the investor will be worse off with dollar cost averaging, as each $25,000 buys progressively fewer shares.
The question of balance
Rapid price changes may throw an investor’s asset allocation out of whack. Say an investor is comfortable with his 60% in equities and 40% in bonds. Then stock prices fall 15%. If bond prices are unchanged, his allocation has drifted to 56% stocks, 44% bonds. To restore the balance, the investor may want to take advantage of the price dip to add more equities to the portfolio.
On the other hand, should equities spike upward, the investor may want to lighten up on stocks to return to the target balance. However, rebalancing may incur tax and transaction costs, so these also must be entered into the equation.
Required Minimum Distributions
Those who are 70½ or older must take annual minimum distributions from their IRAs. The amount is geared to one’s life expectancy, so the percentage gets a bit larger every year.
In the early years, the interest and dividend income from the IRA investments may be sufficient to fund the required minimum distributions (RMDs). As time goes on, however, eventually some IRA assets may have to be sold. The owner can choose any time during the year for making the sale, and one would hope to choose a date near the top of the market. It may be possible to take an RMD in-kind, as a distribution of shares or securities that then can be placed into the taxable portfolio. That eliminates the need to sell, but cash will then have to be generated from another source in order to pay the income taxes on the distribution.
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