How to plan ahead for a big expense
Avoid market timing when investing AND when spending
Good Wednesday morning!
History shows us that if you have a figurative pile of cash, it’s best to invest it into a well diversified long-term portfolio all at once.
In one lump sum.
However, since we’re all humans - and subject to human emotion and psychology - I’ll often recommend a different approach.
Rather than invest a bunch of cash into a portfolio all at one, I’ll instead typically recommend something called dollar-cost averaging (DCA).
Instead of dumping a bucket of cash into the market and hoping for the best, I’ll often recommend we “drip” the cash into your portfolio over the course of several weeks or months.
This helps avoid the chance of unfortunate timing.
Doesn’t feel too warm and fuzzy to dump a bunch of money into a portfolio only to see the market get hammered the next day.
Or next week.
Or next month.
But if we’re investing money into the market, we actually want to buy at lower prices. So it’s ideal to invest into a falling market.
Though with many things in personal finance, this is much easier said than done.
And if the market is screaming higher, it will sting to not have invested everything up front. But that’s hindsight for you…
The solution?
If you want to invest $100,000, $1,000,000, or any large amount of cash into your portfolio, divide it up into equal installments and invest the same amount on the same day every week or every month, depending on your comfort level and personal timeline.
This is essentially what you’re doing if you’ve ever saved into a 401k plan at work. You take some of each paycheck and invest it into your company retirement plan every 2 weeks.
Financially, DCA isn’t the best solution.
But psychologically & emotionally, I’m a big fan.
Most of my clients seem to appreciate this approach as well.
Currently, I have several clients utilizing DCA to invest into their long-term portfolio.
But I also utilize the concept of DCA in other ways as well.
I have a client with a lot of her net worth tied up in a single company’s stock.
We’ve setup a program to sell a fixed amount of these shares on the same day each month which we’re then turning around and investing into her long-term, diversified portfolio.
Another client retired at the beginning of this year and received a big chunk of cash in his IRA that was formerly invested in his employer’s private company stock.
As a result, we’re using dollar-cost averaging to drip part of his cash into his portfolio each month throughout 2024.
But DCA isn’t only about investing money.
What if you have an upcoming expense?
Whether it’s your daughter’s wedding, a home improvement project, or replacing your vehicle, if you’re planning to spend any meaningful amount of money from your portfolio, this could be another opportunity to dollar-cost average.
But in reverse.
Rather than hoping and praying the market doesn’t move against you in the days or weeks leading up to accessing your portfolio for your planned expense, you can DCA in reverse.
If we know you’ll need $60,000 in 6 months, we can start liquidating $10,000 each month ahead of your planned expense and putting the cash into a money market fund - or in your bank account - until you need to actually pay the expense.
By the time month 6 rolls around, you’ll only have to liquidate an additional $10,000 to have the $60K for your expense.
DCA is a simple tool, but it can have significant benefits to your mental well-being whether you’re adding to your portfolio or using your portfolio to live your life.
It’s not the financially optimized solution.
But I’m working with humans, not robots:
And while I can appreciate a spreadsheet as much as the next financial advisor, spreadsheets and software don’t account for your emotional and psychological well-being related to a big money decision.
I can’t see the future any better than you can.
I don’t know what’s going to happen tomorrow.
And using DCA makes this fact a little less scary.
Links & Things
Here’s a short Linkedin article written by David C. Baker.
He references something I’ve written about many times… that in order to help others, you need to first make sure you’ve taken care of yourself.
In other words, you need to put the oxygen mask on yourself:
Baker provides several business examples in his article, but I think the relevance to personal finance and money is worth remembering.
Any additional thoughts? Suggestions?
Hit reply or leave a comment and share what’s on your mind…
Until next Wednesday,
Russ