Beating the Market in Long-Term Investments
Choosing your Savings Future
Whether you already started your long-term investing journey or you are making your first steps onto it, you probably once in a while decide to stack up some more money of your savings to aid the compounding effect on your investments.
It is common sense that whenever you are thinking on buying, you want to buy when the price is low and you want to sell when the price is high - to this matter, I am only considering the first scenario.
Now you are in this situation where you have some money to invest but you check the performance of the target asset and you see that the value is way up than the last week.
“Maybe I should wait for the next week, as the prices might be lower again” — you think.
So next week you check the price and it is actually lower but what if you wait a bit longer? Will the price drop a little more so you can take a better advantage of it?
This is known as trying to beat the market!
The most common outcome of this behaviour is that you will choose the worse time to invest your newly savings. If you think it through, there are actual people working professionally to try to beat the market, like in active managed funds and they hardly beat an Index Fund performance. This said, it is pure luck that someone, that does not study and follows the market, will choose a right time to invest most of the times.
A look into Dollar-Cost Averaging
There is a strategy called dollar-cost averaging which can help you solve this problem and it only requires consistency… and money of course! The way this works is that you mainly need to decide the amount you want to invest and the frequency of when you will invest regardless the asset price.
Imagine you decide to invest 1000€ at the 1st of January every year. Given that the price will probably fluctuate what will surely happen is:
The amount of shares you buy will be greater when the price is lower and lower when the price is higher!
Say that in the first year, January 1st, the price is 50€ per share. You will be purchasing 20 shares. The second year, January 1st, the price goes up to 100€ resulting in 10 shares. On the third year, January 1st, the price drops to 25€ where you receive an amount of 40 shares.
In total, at the end of the third purchase, you will have 70 shares (20 + 10 + 40) and within these 3 years the average price of each share would be:
(50€ + 100€ + 25€) / 3 years ~ 58,33€ per share
But, because you bought more at lower price and less at a higher price, the average cost of each share was:
3000€ / 70 shares ~ 42,86€ per share
Resulting in a 15,47€ saving per share!
Conclusion
Using this strategy over time, you can see that you accumulate shares at an average price below and therefore better than the average stock, mutual fund or bonds being purchased!
References:
- How to Retire Young by Edward M. Tauber
