The Prudent Investor

Letting Dividends Do Their Work

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Dividend Investing Strategies – Dollar Cost Averaging

by George L Smyth

There are numerous strategies for employing dividend investing, which range from the speculative to the conservative.  Dollar cost averaging is a conservative strategy, which I think of as my baseline strategy, and the perfect place for the dividend investor to begin.

“We shall not cease from exploration
And the end of all our exploring
Will be to arrive where we started
And know the place for the first time.”
T.S. Eliot

Long ago I was given a year and a half lead time to prepare for a photographic exhibit that was to be based on water.  For months I would venture from home in search of worthy subjects and make prints with varying darkroom techniques.  A year passed and I felt that I did not have more than a small handful of unconnected pieces, certainly not enough worthy to be shown.  Although I had had direction, I had not had focus.

I decided to toss everything I had done and go back to the beginning, which for me was pinhole photography.  Not only was it a stable starting point for me, but it was also a means to obtain focus.  I found a pinhole sieve that had been given to me and put it in a pinhole camera.  Suddenly it was as if everything had become new.  I very quickly was able to make a dozen prints that hung well together and I still think of it as one of my favorite projects.

Dividend investing using dividend reinvestment programs came to me soon after I started investing.  Over the years I have tried numerous other investing opportunities - some worked well, others not so well.  Having invested in stocks for over two decades I note that I still have a number of the companies I started purchasing in 1997, and they have proven to be excellent investments.  These are the stocks that had been acquired through dividend reinvestment programs, and today about a third of my positions were obtained through the reinvestment of those dividends.

Dollar cost averaging is a baseline for dividend investing not only because it works so well, but also because the basic idea can be used as a launching point for other ideas.  These ideas can be small variations on what I know works through ideas that bring a bit of “spice” to the portfolio.

Dollar cost averaging (sometimes called the constant dollar plan) is a strategy where one breaks up their eventual stake in a company into numerous purchases over a period of time.  This is diametrically opposed to the single purchase, where one immediately places a large bet that the price of the stock will go up over time.

Advantages of Dollar Cost Averaging

The primary advantage of dollar cost averaging can be found in the reduction of risk.  When numerous purchases are made over time, each purchase is made at a different price point.  This means that the exact timing of each purchase becomes less significant.  As one who has seen (all too regularly) an immediate drop in a stock’s price directly after purchase, it can be disheartening to think that had I waited a day or two to make the buy, the eventual gain would have been better.  Dollar cost averaging oftentimes has investors actually hoping for a drop in the price of their own stocks.

A great example of dollar cost averaging is the contribution one makes to their 401(k) plan at work.  From each paycheck a specified amount of money is sent to the plan’s administrator to purchase index or mutual funds.  That amount buys the number of shares that can be bought with the amount applied.  There is no concern for the exact timing of each purchase, just faith that the instrument will increase in value over time, the same faith for all investments.

If one is bought every other week, over the course of the year 26 bi-weekly purchases would be made at 26 different purchase points.  The amount invested when the fund is doing well does not purchase as many shares as when it is not doing well.  This is why those fortuitous and unplanned dips just before a purchase are always welcome.

Of course, the idea is that when the investor wants to move money from the fund that it will be doing well – at least better than it was during the times of those purchases.  This is why I usually suggest that people look at a long term chart for the S&P 500, understand its generally upward trajectory, and consider investing in an index fund that tracks it.

An Example of Dollar Cost Averaging

As an example of dollar cost averaging let’s take a look at Aqua America (WTR), a stock in my portfolio.  Below is a list of the closing values on the first day of the month for the past two years.

Date Close Shares Date Close Shares
1/1/2018 $36.21 2.76 1/1/2019 $35.05 2.85
2/1/2018 $34.19 2.92 2/1/2019 $35.94 2.78
3/1/2018 $34.06 2.94 3/1/2019 $36.44 2.74
4/1/2018 $35.15 2.84 4/1/2019 $39.06 2.56
5/1/2018 $34.70 2.88 5/1/2019 $39.54 2.53
6/1/2018 $35.18 2.84 6/1/2019 $41.37 2.42
7/1/2018 $36.94 2.71 7/1/2019 $41.95 2.38
8/1/2018 $37.18 2.69 8/1/2019 $44.29 2.26
9/1/2018 $36.90 2.71 9/1/2019 $44.83 2.23
10/1/2018 $32.53 3.07 10/1/2019 $45.33 2.21
11/1/2018 $34.29 2.92 11/1/2019 $44.27 2.26
12/1/2018 $34.19 2.92 12/1/2019 $46.94 2.13

Assuming that one had made $100 purchases at the close of each of these dates (in a program that allowed for the purchase of partial shares), the investor would currently have about 63.5 shares of Aqua America, valued at $3,214, with an average purchase price of $38.19.

A single purchase made before April 1, 2019 would have yielded better results for this rising stock, so there is the case to be made that dollar cost averaging may not be using one’s money as efficiently as possible.  However, had I used 3M as an example (another stock in my portfolio) then the opposite would have been the case.  I will look at an actual means of comparing these two strategies in a moment.

The point is that there is considerably less stress when it comes to the issue of timing.  One seldom sees co-workers worrying about when the purchase to their 401(k) will be made, it is something that happens pretty much without notice, so no stress there.  Hoping that a one-time bet works out is great when it does.  But being forced into a long term strategy takes much of the pressure out of the situation.

Dollar Cost Averaging vs. Lump Sum Investing

Of course, this is not a panacea – nothing is.  For one, investing in a lump sum gets the money working more quickly, and if the market is rising then more money can be made than if that money was sitting on the sideline.  That said, if the market falls then losses come more quickly.

This whole subject works on the assumption that one has a large sum of money to invest in the first place.  In the real world not everyone has a spare $5,000 or $10,000, and considerations between dollar cost averaging and lump sum investing are more in tune with hypothetical questions like what one would do were they given $10,000.

But many of us do have a spare $50 or $100, and for those fortunate in their budgeting this is a regular occurrence.  Waiting until one has a large sum of money to invest all at once can take a while to save, and in a market that is rising that is money that is not taking advantage of that rise.  Additionally, there is an even greater stress level for those who have waited months to place their bet all at once than those who are making multiple small purchases.  Simply put, for the majority of people, investing a little at a time is the only option.

The advantage investors have these days is the availability to brokers who allow for investments without a fee.  Examples are Ally, Ameritrade and E*Trade.   This means that instead of 10% being taken away from a $50 purchase, as has been the case in the past, the entire amount can go toward buying the stock.  This has not always been the case and hopefully the trend will remain for a long time.

One can go back and forth with the argument as to whether dollar cost averaging or lump sum investing works better for them.  The bottom line is that there is no absolute answer, as results are dictated by the events of the time.

MoneyChimp has a handy program that allows one to test whether dollar cost averaging or lump sum investing works better. They perform two tests, assuming that $10,000 is invested in the market over the course of a year.  The first section tests a lump sum invested into an S&P 500 index fund all at once, and the second section tests equal amounts invested at the beginning of each month for a year, with the balance of the original amount sitting in an interest bearing savings account.  By entering the bank’s interest rate and the start date (from 1950 to present) the two tests show the amount one would have resulted in a year’s time.  It can be seen that depending upon the date selected and the interest amount entered, each strategy has an opportunity to outperform the other.

Dollar cost averaging is a means of reducing the stress associated with trying to time the market.  It is especially suited to the small investor without large resources, as well as those who enjoy their sleep at night.  It is a powerful tool that provides a system that promotes disciplined investing and should be a consideration for all investors.  This is why I consider it to be the baseline strategy for dividend investing.

 



This website is maintained by George L Smyth