Physician Investment Strategy: Dollar Cost Averaging
While physicians may have a greater opportunity to earn a high income, the initial delay and expense of entering their practice puts them at a disadvantage in wealth accumulation which can have a compounding effect over the different stages of their professional life cycle. For that reason, young physicians need to begin a long-term investment program early in their career. The stock market is still the best way to accumulate wealth over the long-term, and for investors with little or no capital to invest, dollar-cost-averaging is the best way to build an stock portfolio..
How Dollar Cost Averaging Works
The key to the strategy is to commit to a fixed dollar amount of investment each month. You can allocate your funds among a small group of stocks, mutual funds or exchange-traded funds. Your fixed investment amount will purchase a certain number of shares based on the prevailing prices. When share prices drop, your fixed amount will purchase more shares, and when the share prices rise, it will purchase fewer shares. Assuming that the general trend in stock prices is always up, as it always has been, your cost-basis will always be lower than the current share price after the market has gone through a complete cycle.
Here’s a hypothetical that shows dollar cost averaging in action. Let’s say you select an index mutual fund that is currently trading at $25 per share. Your first monthly investment of $500 will purchase 20 shares. As the price of the mutual fund shares fluctuate, your $500 will buy a varying number of shares each month. Over a period of a year it might look something like this:
In this example, you will have accumulated 249 shares and your cost-basis will be $24.25 per share (based on an average of your purchase prices). The closing price in the 12 month is 28, which means you would have made money anyway on your initial purchase. However, you also purchased shares at higher prices (26, 27 and 28). Because your timed purchases also acquired a number of shares at lower prices, it brought down your average cost-basis giving you a bigger profit. Over the course of the year, you have invested $6,000 with an ending balance of $6,972 which amounts to a return on investment of 16%.
Is Dollar Cost Averaging the Best Strategy for You?
If you don’t have a lump sum of capital to invest right now, dollar cost averaging may be your only strategy. It is still strongly recommended that you have the ability to allocate a portion of your savings towards safe, fixed yield or income investments such as money market funds or government bond funds. You can achieve diversification in stocks over time, but it is important to have a portion of your savings held in secure accounts to stabilize your overall portfolio.
The advantage of dollar cost averaging is that you don’t need to concern yourself with market timing (which doesn’t work for most investors), and, assuming the market continues on its upward path over the long-term, you are almost assured of positive returns.