If the market is performing well or at all-time highs, the concern is usually whether an inevitable pullback or stagnation is just around the corner. If the market experiences a correction, the typical psychological reaction is that the market will continue its downward trend. Investors often miss out on opportunities that arise once every ten years because of their attempts to “time the market”.

A bear market is traditionally defined as a decline of at least 20% from all-time highs and typically lasts between 6 and 18 months. During this period, there is usually a single day that represents the market bottom and marks the peak of negative sentiment. From this perspective, there are typically an average of 253 trading days in a calendar year, which makes the probability of picking the bottom of a bear market somewhere between 1 in 125 and 1 in 375.

Given how difficult it is to time the market and how volatility can significantly impact your portfolio’s short-term performance, how can you try to benefit from a market trading at a significant discount?

One strategy we believe can address this challenge is Dollar-Cost Averaging.

Investopedia defines dollar-cost averaging as “an investment strategy in which an investor divides the total amount to be invested into periodic purchases of the target asset in order to reduce the impact of volatility on the total investment” .

Simply put, this strategy involves investing funds periodically at predetermined intervals over a specific period of time.

We can understand why die-hard bulls who believe the market will rise in the long term might think it’s unnecessary to stay out of the market. However, for a first-time investor, the idea of trying to time the market’s bottom is always the primary emotional reaction and can cost them a significant portion of potential returns.

For example, suppose I have $100,000 that I want to invest in the market. My first option is to invest it all today, which is shown in the “All at Once” column. My second option is to invest $20,000 each month for the first 5 months, which is shown in the “Dollar-Cost Averaging” column.

By investing “All at Once,” the portfolio drops by more than 20% at the start and then manages to yield a return of minus 10%, whereas the Dollar-Cost Averaging strategy drops by just under 13% and then remains only slightly in the red.

Now, experienced investors will rightly point out that the market shows an upward trend over the long term and that the most important factor is “time in the market, not timing the market.” If you were to use the same example for every year of the past decade, there would be only a few periods where Dollar Cost Averaging would have been more profitable. However, for inexperienced investors, the possibility of losing more than 20% of their portfolio within four months can be disheartening.

This is where Dollar-Cost Averaging really shines; it can potentially deliver a better short-term return, while also alleviating some of the anxiety and stress caused by your portfolio taking an initial hit.

There are currently two different views on the market’s trajectory. First, some investors believe the market will show a “V”-shaped recovery; in this scenario, Dollar-Cost Averaging could help smooth out some of the short-term volatility that has been troubling the market this year. The second view is that we will experience a “W”-shaped recovery; in this scenario, Dollar-Cost Averaging helps reduce your initial exposure to a market pullback while potentially lowering your entry price.

Another key advantage of Dollar-Cost Averaging is its ability to limit the emotional burden of losing money. For many investors, the fear of losing money is greater than the prospect of making money. This is particularly evident among investors who are new to the market and are not yet accustomed to its cyclical nature. This can lead to a loss of confidence and, in some cases, cause individuals to withdraw from the market entirely.

Like most investment strategies, Dollar-Cost Averaging is suitable only for certain investors and should be used as a tool to hedge against volatility, not as a “magic wand” for investing. The most important thing to remember is that, in the long run, the cost of staying out of the market is almost always greater than the cost of staying in the market.