- spend less than you make
- stay out of debt
- save up for big purchases (i.e. car, house, engagement ring)
- invest regularly
While I often have no problem reciting and acting on the first three above, the fourth one seems so counterintuitive.
Surely it can't be that easy.
So, I wanted to figure out when's the best time to invest my money.
For the purpose of this case study, I wanted to see what strategy would work best, in terms of final total value, over a 23 year period (why 23 years, well since you asked, because the SPDR S&P 500 has been around since January, 1993, and 23 years gives us a pretty good idea of a long-term track record).
Obviously there are limitations to any study like this, especially one that is back-tested, but I wanted to see if there was a difference between dollar-cost averaging and perfectly picking the bottom of the market. I should define these terms in that case of the study:
Dollar-cost averaging: investing a set dollar amount ($500 for this test) on a regular schedule (I picked end of each month)
Perfect Picking: picked the bottom of the market after it set a high (meaning, cash piled up until the very bottom tick, at which time all the money piled up was invested into the index)
For the sake of this test, I assumed that in both strategies, the investor had $500 at the end of the month to invest. In the dollar-cost averaging strategy, the investor put in the $500, regardless of the value of the stock (which is the SPDR S&P 500 ETF - SPY). In strategy two, the investor put $500 in January 1993, the waited for the next lowest point (with perfect intuition to pick the absolute bottom - impressive, huh?!) to then deploy all the cash that he had saved up.
Here's how the two studies compared over a 23 year period:
For the purpose of this case study, I wanted to see what strategy would work best, in terms of final total value, over a 23 year period (why 23 years, well since you asked, because the SPDR S&P 500 has been around since January, 1993, and 23 years gives us a pretty good idea of a long-term track record).
Obviously there are limitations to any study like this, especially one that is back-tested, but I wanted to see if there was a difference between dollar-cost averaging and perfectly picking the bottom of the market. I should define these terms in that case of the study:
Dollar-cost averaging: investing a set dollar amount ($500 for this test) on a regular schedule (I picked end of each month)
Perfect Picking: picked the bottom of the market after it set a high (meaning, cash piled up until the very bottom tick, at which time all the money piled up was invested into the index)
For the sake of this test, I assumed that in both strategies, the investor had $500 at the end of the month to invest. In the dollar-cost averaging strategy, the investor put in the $500, regardless of the value of the stock (which is the SPDR S&P 500 ETF - SPY). In strategy two, the investor put $500 in January 1993, the waited for the next lowest point (with perfect intuition to pick the absolute bottom - impressive, huh?!) to then deploy all the cash that he had saved up.
Here's how the two studies compared over a 23 year period:
As you can see from the total portfolio value graph above, the dollar-cost averaging component seems to move in tandem with the perfect timing, although slightly above during most of the 90s and 2000s which saw long bull runs, with sudden and dramatic pullbacks.
Ultimately, this study brought to mind a couple of questions that I have to answer for myself:
- How good will I be at timing the market to pick the bottom?
- Is all that hassle even worth it?
For me personally, I believe that this points to steady and constant investment in the market over time will ultimately produce solid returns.
SDG
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