Why Suze Orman’s Most Popular Investment Method Could Cost You Money
While Suze Orman is known to be quick with a joke, the personal finance celebrity usually tells investors to take it slow and steady.
Orman is one of the biggest advocates of dollar cost averaging. Rather than investing all of your available money at once, this technique encourages you to keep investing equal proportions over time.
It’s a less risky way to get public, Orman says. However, new analysis shows that the greatest return is usually achieved when you put all of your cash in as quickly as possible.
Here’s what the numbers say – and why the real answer isn’t always that simple.
The case for dollar cost averaging
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Orman, a bestselling writer and television personality, says dollar cost averaging (DCA) “gets the time, your money and the market on your side.”
You may already be using DCA through a company retirement plan, such as a 401 (k), with a portion of each paycheck going to the account. And some popular investment apps allow people to take the same approach by setting up automatic deposits every week.
For example, let’s say you decide to invest $ 100 a month in gap stocks. Today you can use it to buy four shares – but with DCA, you don’t make decisions based on the number of shares you get.
If the price plunges 50% in the next month, that $ 100 can now be used to buy eight stocks. Sounds like a bargain! What if the price doubles instead? To offset the risk of buying too high, conservatively buy only two stocks now.
“In times when the markets are very confusing and they are rising and falling … if you have the dollar cost average and the markets fall and eventually the markets rise again, you will most likely make more money than if you invested in a lump sum”, Orman said on her Woman & Money podcast last year.
However, a new study says it usually doesn’t work that way.
Quickly from the starting block
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By sitting on extra cash longer than necessary, investors using DCA are missing out on the growth that comes with spending more time in the market, according to Northwestern Mutual.
The story goes on
The financial services firm first looked at the rolling 10-year return on a $ 1 million investment in the US markets. It then looked at how much you would make if you had that $ 1 million investment evenly spread over 12 months before waiting for the remaining nine years.
The company found that at the end of 10 years, an investment of $ 1 million at a time produced better returns than the dollar cost, which averaged nearly 75 percent of the time. This is independent of the asset allocation.
“Essentially, the data support the adage: Time in the market beats the timing of the market. The investment (a) Windfall enables an investor to get returns on all of their capital right from the start, ”the report says.
Actually:
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With a 100% fixed income portfolio, lump sums exceeded the dollar cost an average of 90% of the time.
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In a traditional 60/40 split, lump sums won 80% of the time.
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And with a 100 percent equity portfolio, investments outperformed 75% of the time.
“Observations that flat-rate investments outperform are associated with markets that have trended higher over time while the average dollar cost outperformed when implemented in lower trending markets,” the report said.
“Historically, there are more years in which the markets tend higher, which also means that flat-rate investments outperform.”
So what’s the right step?
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While history seems to support one style of investing, the choice between flat fee and DCA isn’t obvious.
“If you only use historical data in this investment decision, you are ignoring the behavioral and emotional side of investing,” said Matt Wilbur, senior director of advisory investments at Northwestern Mutual.
If the fear of investing a lot of money at once is preventing you from investing at all, you might benefit from the slow and steady method. DCA is also better than holding your cash while you wait for “a good time” to invest, the study found.
And despite Orman’s passion for dollar cost averaging – she even has a DCA calculator on her website – the finance guru admits that she recommended going all-in in 2007 and 2008, when markets collapsed.
“But we are in uncertain times right now. So if you don’t know what to do, that way you can invest and you can probably stay ahead in the long run, especially when the markets are volatile, ”she says on her podcast.
Put your strategy into action
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Note that the decision on whether to use an investment or a DCA only applies if you actually want to invest an amount of capital.
When you do this, make sure that you spread your large investment out to minimize the risk. Check out one of today’s most popular robo-advisors if you’re unsure how to build a balanced, diversified portfolio.
If you prefer the benefits of calculating averaging costs or if you don’t have a lot of money to spare, many apps let you automate small, regular investments.
Some of these apps offer fractional trading, which allows you to buy parts of expensive stocks like Apple or Tesla, no matter how small your monthly deposit is.
Another option is to choose an app that will invest your “spare money”, round up your daily purchases to the nearest dollar, and invest the difference.
This article is for information only and is not intended as advice. It is provided without any guarantee.
