Reality Check: Dollar-Cost-Averaging is a technique where you periodically purchase the same dollar amount of an investment whether the stock market is up or down. When it is up, your dollar amount buys you less. Conversely, when the market is down you get more shares. When you are saving for retirement, this approach can result in a lower average purchase price and that’s a good thing. However, when it is time to start drawing money out (like when you are in retirement) putting this dollar-cost-averaging strategy in reverse can be very dangerous because you may have to sell more stock when the market is at a low point. Would you like an example?
Reality Can Stink: The S&P 500 index declined about 1% from 2000 to 2009 – often referred to as the “dead decade.” Let’s say you retired at the end of 1999 and left your $300,000 nest egg in the stock market. You then proceeded to draw out just 4% per year (touted by many as a “safe withdrawal rate”). That translates to you taking out $1,000 per month over ten years (2000 to 2009). How would you have fared? Well, you would have drawn out $120,000 of your own money, lost $72,000 due to the decline in the market, and would have $108,000 left to see you through the rest of your retirement (that would be nine more years of income if you converted the stocks to cash). As you can see, putting dollar-cost-averaging in reverse can do more harm than good, that’s why I call it Dollar-Cost-Ravaging.
A Better Reality: What if you hadn’t stayed 100% invested in the stock market, and you had moved $120,000 into a safer investment that earned 3%? The remaining $180,000 could still have been invested with the hopes of stock market growth. Now let’s replay 2000 through 2009 and see where you would end up. You would have the same withdrawal of $120,000 (this time withdrawn from the safer investment), a loss of “only” $28,000 because of market decline, and $152,000 left over. In this example, there would be $44,000 more for your retirement (about four more years of income) by not putting your entire nest egg at risk.
None of us can see the future, but for those of you familiar with the mantra “Past Performance is No Guarantee of Future Results,” I say, “Prior Performance (of haphazard investing strategies like Dollar-Cost-Ravaging) Can Be Indicative of Future Results.” Be cautious and build a plan!
Have a financial question you'd like answered here? Email: Questions@PlanStronger.com