The Highs and Lows of Dollar-Cost Averaging

Investors who defer the same amount of money from their paycheck into a 401(k) plan at regular intervals are practicing dollar-cost averaging. By investing the same fixed dollar amount each time, the investor buys more shares when prices are low and fewer shares when prices rise.¹ The long-term effect is that the average cost of each share purchased will be lower than the average share price.²

This strategy can work great when you are trying to accumulate assets for your retirement. But what happens when you withdraw from your investments for retirement income? While dollar-cost averaging reduces the risk of investing a lump sum of money when prices peak, it increases your risk of losing previous gains if you withdraw money when prices have dropped. If a retiree receives automatic systematic withdrawals for a fixed level of income, then in months when share prices drop, he or she will likely have to sell more shares to raise the needed money. Once those shares are sold, they never have the ability to recover lost gains.³

To create a more prudent income distribution plan, you may consider incorporating some solid, reliable income in your portfolio, in addition to Social Security benefits. This typically comes in the form of a principal guaranteed account.⁴ If you’d like to discuss how to position your assets to combine both income producing assets and growth opportunity, please contact us.

It’s a good idea to develop multiple streams of retirement income. Ideally, you want to draw income only from stable accounts that increase in value and avoid drawing income from accounts that are down.⁵ Also, maintain a healthy portion of assets in a liquid account to help pay for periodic expenses when you don’t want to tap your investments.

For those who don’t utilize an income distribution plan in retirement, when the markets take a dive, the other option is to be flexible with your retirement budget. This means having a Plan B budget. When the markets take a downturn, you can switch to budget B, and downsize your expenses, perhaps by cutting out vacations, large purchases and eating out for a while. It can be a big lifestyle change, which you probably remember seeing in 2008 when retirees had to go back to work. A safer option is to use a distribution plan in retirement, this can help you avoid having to change your lifestyle when the markets drop again.

¹ James Chen. Investopedia. March 16, 2020. “Dollar Cost Averaging.” https://www.investopedia.com/terms/d/dollarcostaveraging.asp. Accessed July 10, 2020.

² Dan Burrows. Kiplinger. April 17, 2020. “Dollar-Cost Averaging: How Does DCA Work, And Should You Do It?” https://www.kiplinger.com/article/investing/t052-c008-s001-dollar-cost-averaging-how-does-dca-work-should-you.html. Accessed July 10, 2020.

³ Matt Becker. The Simple Dollar. April 9, 2020. “The Truth About Dollar Cost Averaging.” https://www.thesimpledollar.com/save-money/the-truth-about-dollar-cost-averaging/. Accessed July 27, 2020.

⁴ Dennis Ho. The Street. July 2, 2020. “How to Use a Deferred Income Annuity to Avoid Running Out of Money in Retirement.” https://www.thestreet.com/retirement-daily/planning-living-retirement/how-to-use-a-deferred-income-annuity-to-avoid-running-out-of-money-in-retirement. Accessed July 10, 2020.

⁵ Jeff Rose. Forbes. Nov. 2, 2017. “5 Ways To Generate Different Sources Of Income.” https://www.forbes.com/sites/jrose/2017/11/02/different-sources-income/#42d46f7137bb. Accessed July 10, 2020.

Content prepared by Kara Stefan Communications.