A Simple Strategy Using The S&P 500 Index ETF That Is Beating Other Approaches (SPY, INDEXSP:.INX)

Nilus Mattive: Back when my daughter was born in June of 2007, I used the occasion to talk about the simple investment strategy known as dollar-cost averaging.

And just about every year since then, I’ve used this column to update you on how a hypothetical investor would be faring by using the approach.

As hard as it is for me to believe, the time has already come around again!

Yes, five years have already passed … which really only proves one of the biggest points I continually make here — that because time goes by so quickly, it’s crucial that you plan for the long-term as early as possible.

So without any more sappy thoughts or clichés, let’s turn our attention to what another year of dollar-cost averaging would have done for us …

First, a Quick Recap of What Dollar-Cost Averaging Is All About!

The idea with dollar-cost averaging is relatively simple: You buy equal dollar amounts of the same investment on a predetermined schedule.

Please note the italics in that last sentence. Dollar-cost averaging IS NOT buying a fixed number of shares on a regular basis. In fact, it is quite the opposite. Here’s why …

Let’s say you’ve decided to invest $10,000 in XYZ Corp. Rather than deploying the entire amount at one time, you might instead opt to purchase $1,000 of XYZ stock on the first day of each of the next 10 months.

What’s the logic behind this approach? Well, you can expect just about any stock’s price to vary substantially over a 10-month period. So, when the price is higher, your $1,000 will buy fewer shares; when the price dips, your $1,000 will buy more shares.

In other words, buying equal dollar amounts over time allows you to reduce your risk to a stock’s short-term price movements, automatically encouraging you to buy more when prices are lower and less when prices are higher.

It also removes much of the emotion from the investing process. You’ve already committed to buying the stock at regular intervals, regardless of market conditions.

And because you’re doing this automatically, it doesn’t require more than a few minutes of your time (if any at all!).

Okay, But How Does This Strategy Fare When the Road Gets Bumpy?

Obviously, buying bits of stock as the market continually rises would work just fine … even if it meant you missed out on some additional upside by not putting as much in as quickly as possible.

But what about the other scenario — the one where the market really zigs and zags, moves sideways, or even goes lower over a long period of time?

Well, the last five years are a perfect illustration of just such a market!

Take a look at a chart of the S&P 500 Index (INDEXSP:.INX) since my daughter’s original birthday …

As you can see, despite the huge declines and rallies, the broad U.S. stock market index is STILLlower than it was five years ago!

And yes, if you’d had very good timing, you could have clearly been making a fortune during every one of those major moves … but what if you didn’t have perfect timing?

Or worse yet, if you had BAD timing?

That’s where dollar-cost averaging comes in. Let’s look at what would have happened if you simply followed this approach over the last five years — investing an equal amount of money in the S&P 500 ETF (NYSEARCA:SPY) at the beginning of every single month.

It’s a long table, but I want to show you exactly how this works …

Broad Based ETF chart
Click on the table for a larger view.

As you can see, by putting $1,000 into a broad-based ETF each and every month over the last four years, you would have spent $61,000 to buy a total of 546 shares.

Based on the SPY’s recent price of $128.16, that total stake would currently be worth $70,017 — a total profit of $9,017!

That’s a 14.78 percent return over the five years … even though the market actually FELL 14.67 percent over the same time period!

The reason, as I mentioned earlier, is simple: While you would have bought some shares when the market was at its peak, you also would have forced yourself to buy a bunch of shares when the market was much lower than it is today.

Now, let me point out a few more things about these numbers:

FIRST, the overall performance number actually went down from last year’s review (+18.66 percent) and the total profit figure in dollars stayed the same.

In other words, our hypothetical investor didn’t make any additional money over the last year. But he did save another $12,000 and because this is a long-term strategy, I wouldn’t be particularly bothered by a year of flat performance.

SECOND, I’m sure you’ve already realized that on an annual basis, our investor has made a bit less than 3 percent a year. While that isn’t anything to write home about, it IS better than most other conservative investments have been paying … and is at least in line with inflation over the same five-year period.

THIRD, I am NOT holding dollar-cost averaging out to be the end-all-be-all solution.

In fact, I continue to believe that careful timing and superior stock selection will give you even BETTER returns!

[Editor’s note: You can get all of Nilus’ specific recommendations for just $39 a year by clicking here.]

But in the case of buying individual stocks, it’s worth noting that you can apply dollar-cost averaging there just as easily as you can with broad-based ETFs.

In addition, you are also using this same general concept whenever you reinvest your dividend payments or make regular contributions to the same funds in a retirement plan such as a 401(k).

Of course, whether or not you decide to put dollar-cost averaging to work in your portfolio, the important part is remembering that while time often passes more quickly than we might like, the key to success — in both investing and life — is finding a way to capture those key moments that happen along the way.

Best wishes,

Written By Nilus Mattive From Money And Markets

Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Nilus Mattive, Claus Vogt, Ron Rowland, Michael Larson and Bryan Rich. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical in as much as we do not track the actual prices investors pay or receive. Regular contributors and staff include Andrea Baumwald, John Burke, Marci Campbell, Selene Ceballo, Amber Dakar, Maryellen Murphy, Jennifer Newman-Amos, Adam Shafer, Julie Trudeau, Jill Umiker, Leslie Underwood and Michelle Zausnig.

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