Investing is a tricky game. You need to know what you’re doing, or you could end up losing your shirt. I know all about that. When I started investing years ago, I fell for the trap that most newbies fall for—buying when prices had already gone up exponentially.
I mean, you can’t really blame me. It makes sense that prices will continue to rise, right? Yeah, I don’t think so.
Not only did I buy the top, I entered one of the most volatile financial markets—cryptocurrencies. I know, I know. It was a bad idea. But that’s part of the learning process. Most of us lose money before we learn from our mistakes and then eventually make a buck or two.
What happened to me
Since then, I’ve learnt plenty about investing. But not before my portfolio crashed by 90%. Oh, yeah. I forgot to mention that part.
That wasn’t fun. But I needed to get burnt to know that I should never touch a hot stove plate ever again. And luckily for me, I learnt. One of the good things that I did was not selling in a down market. I learnt that I lose money only if I sell. Sure, there’s a chance that my assets could’ve gone to zero, but they didn’t. As terrifying as the tumultuous rollercoaster ride was (for years), I stuck it out.
So I learnt that I should just stick it out. But that doesn’t mean that strategy is great for every asset. Remember Enron?
Fortunately for me, the bear market eventually came to an end, and I recovered lost ground as prices spiked up. That made me wonder about the things that successful investors do. Sure, they probably weather the storm, but there’s got to be more than that. I figured they knew when the bottom was, so they bought when prices were low. And they surely must know when prices have reached the top.
I figured out that most smart investors didn’t know more than me. Huh? How is that possible? Surely they must know something about investing that I don’t, and it’s that one thing that made them successful? Sort of. It’s not one thing they knew, but rather, one thing they did.
I found numerous cases of teachers, accountants and courier drivers making 50, 60 or $70,000 a year and eventually retiring with a multi-million dollar net worth. But how? What was their secret?
It wasn’t that they invested in an asset that exploded and returned 1000% in a matter of months or that their investment had low fees. It was something else.
Prepare to have your socks blown off
Most of those smart investors knew even less about the financial markets than me, but they were successful because they did one thing I hadn’t done.
Smart investors fund their investments consistently.
What a bunch of nonsense! you might say. Surely that can’t be it? Just think about it. If you kept funding an investment every week or month for decades, I’m sure you would agree that the investment would grow significantly, right? Yep. A high rate of return hardly ever provides a bigger portfolio with infrequent deposits than a regular rate of return with consistent deposits.
It’s the consistent funding of their investments that made regular workers such as teachers, accountants and courier drivers retire with millions of dollars.
The masters say that discipline and 10,000 hours of practice will lead to mastery. Well, by investing regularly, those regular workers developed discipline and tremendous practice. Whether the market was up, down or ranging sideways, those multi-million dollar retirees kept putting money into their investment. It’s called dollar-cost averaging.
Dollar-cost averaging
Using this investment technique provides several benefits. Firstly, it teaches an investor to ignore their emotions. When the market is crashing and they’re scared, they invest. When the market is in a bull run and they’re greedy, they invest. So whatever they’re feeling doesn’t influence their decision. It’s the discipline that makes them invest.
The other benefit is that it decreases losses. Let’s say you buy a stock when it’s $100. Then the price crashes to $50. If you hadn’t bought when the stock crashed, your loss would be $50 (100-50). But if you bought the stock again at $50, you would’ve lost only $25. That’s because $100 plus $50 is $150. You’ve got two shares, so you divide by 2, and that makes your portfolio value $75. Subtract that from $100, and your loss is only $25.
But the same is true in a bull market. Your gains are reduced.
Let’s say you bought a stock at $100, and its price increased to $150 when you bought it again. Had you not practised dollar-cost averaging and bought again at $150, your portfolio would be worth $150. But since you bought again after the price surged, your portfolio’s value is $125 [(100+150)/2]. So Instead of a $50 increase (150-100), your portfolio increased only by $25 (125-100).
Wrapping it up
Evidently, there are upsides and downsides to dollar-cost averaging. But the long-term benefit, which many regular workers who retired as millionaires proved, is that consistently funding a safe investment over a long period is very lucrative.
While I do agree that is a winning strategy, I also think it’s important for investors to know what investment is safe. Fees can take a big chunk of profits, so it’s also important to know all of the expenses and taxes involved.
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