Index investing is about following an index, but this project is also about making regular investments. This has several benefits, which will be discussed below. However, there is more to consider.
Put your money to work ASAP
The first benefit is that you invest your money as soon as it is available. That way, you have the most of your money invested in the stock market, thus benefiting the most from it’s expected growth.
It is not about timing the market, but about time in the market
Keep in mind that I’m not suggesting to invest all your money. You should keep a certain amount save and readily available in case unforeseen events happen. Your washing machine or car might need break down, or you could lose your job. These unfortunate events do happen, and when it does, you want to have an emergency fund (to be created).
Dollar Cost Averaging (DCA)
Another benefit of making regular investments is dollar cost averaging. DCA means that by investing a fixed amount into the same fund on a regular basis, you average the price. But it is not a normal average number, its a weighted average. That has a great benefit: the average price you have paid, will be lower than the average price!
Let me explain this principle with an example. Suppose you invest $1000 every month into an index fund. The index will vary in price, as will the underlying stocks. Suppose also that the index price will be $11 in January, and $9 in February. The average price will be $10. However, your $1000 per month investment will have bought (1000/11=) 90.9 shares in January and 111.1 shares in February. In total, you have 202.01 shares. Your DCA price, the weighted average price is not $10, but (202.01 / 2000) $9.90 per share! This is because you were able to buy more cheaper stocks than expensive stocks.
So, when stocks are a bit more expensive, you buy less stocks. Conversely, when stocks are cheaper, you can buy more stocks for the same fixed amount of money. The result is that the cheaper stocks have more than 50% of the weight in the total.
Even in a long term flat market, you can make a profit with DCA.
How often should I make regular investments?
So far, we discussed the benefits of making regular investments. In fact, if we tried to get as much time in the market as possible, and try to maximize DCA, we would make as frequent investments as possible. However, there are costs involved with every transaction. We cannot disregard Rule number 1: keep costs to a minimum.
So, there is a trade off between the benefits of regular investments and the costs which begs the question: How often should we invest? We can invest small amounts every week, a fixed amount every month, or save up amounts and invest every quarter or even once a year. I will make a calculation based on my specific situation, but feel free to plug in your own numbers in my Investment Frequency calculator (to be created).
|amount available||€1000 per month|
|transaction costs||8.5 + 0.15%|
I should be making regular investments. Optimally, I would be making investments about once a month. Albeit small differences between montly and quarterly, this should have the best results for me in the long run.