The Best Investing Strategy for New Investors

The strategy is to adopt a long term buy and hold investing mindset, while you invest and take action tactically using the dollar cost averaging method. Let us explain why. The reality of investing is that markets go up, and markets go down. A second reality is that it is almost impossible to perectly time the market so that you are maximizing your gains and minimizing your losses. Lets explain this further using the S&P 500, an index which tracks the 500 biggest companies in the US.

The snap shot of the S&P 500 above is from 1983 to 2023. As you can see, the overall market has gone up tremedously over the course of 40 years. However, during the overall upward trajectory, there have also been major market crashes. The most notable in recent years have been the Dot.com bubble between 1999 and 2000, the financial crisis of 2008 and the coronavirus crash in 2020.

Lets say that you started investing back in 1993. The market would go up until the Dot.com bubble, and then crash. The market would then slowly rise back up, and crash again in the financial crisis of 2008. The market would then recover again and go on a major run until the coronavirus crash in 2020.

In an ideal world, you would sell your investments at the top of the market, and reinvest in the bottom of the market to maximize your gains. The problem with this? It is almost impossible to perfectly time. That is why a long term buy and hold strategy using dollar cost averaging takes advantage of the overall upward trend of the market given enough time. Lets explain how this actually works below.

The strategy has two components to it, so lets look at both. First, the buy and hold mindset. This is exactly what it sounds like. The whole idea is to adopt an attitude that you are going to buy and then hold your assets over a long time horizon.

As explained above, you want to embrace this mindset as the market historically goes up over a long enough time horizon (obviously not all the time, especially in the short term). Having this long term mindset will help eliminate emotions, fear, and help you stay consistent knowing that you are giving yourself a good chance at positive returns over a long enough time.

The second component to this strategy is to consistently invest in your portfolio using dollar cost averaging. Dollar cost averaging is a strategy in which you buy assets in your portfolio at regular intervals regardless of if the assets are up or down in value. Typically, you will invest into your portfolio every single month and make investments regardless of if your portfolio is up in value, at the same value, and or down in value, even for an extended period of time.

Dollar cost averaging does two things. First, dollar cost averaging can help reduce the cost of each asset per share over a long enough time horizon as you are buying when the market is down, and when the market is up. Secondly, dollar cost averaging banks on the historical return of the overall market going up, and therefore uses compound interest to grow your assets over time.

On a practical level, here is what this strategy looks like. Lets say you are 25 years old and want to save and invest for your retirement at age 65. You could dollar cost average $500 per month into a good retirement account over the course of that 40 years, and you would end up with $1.5 million in retirement given an 8% average return thanks to compound interest.

Inevitably, the value of your investments will go down at somepoint during those 40 years as the market goes up and down. But if you stick with the strategy, history tells us the market will go up anywhere from 8% to 12% minus inflation if given enough time. Now it is not a guarantee that history will repeat itself, but it is the most likely case given that the market typically recovers from crashes over time.

1) It will eliminate emotions and fear. When you dollar cost average, you buy into your portfolio whether the market is up, or whether the market is down as you are banking on the overall historical positive return of the market given enough time. Doing this can help eliminate your emotions and not panic when things are going bad, or make rash decisions when things are going well.

2) Eliminates timing the market. It is almost impossible for anyone to perfectly time the exact ups and downs of the market, even professional investors. Dollar cost averaging eliminates the need to time the market by continually investing over time.

3) Anyone can do it. The best part about dollar cost averaging is that anyone can do it. You don't have to be a professional investor, you just have to have the discipline to stick with the strategy and withstand the inevitable downturns in the market.

1) Potential to miss higher returns. The main argument against dollar cost averaging is that you are missing out on potentially higher returns. This is true. However, in order to get these higher returns you typically have to time the market, or choose better investments, both of which are challenging for an average investor to do.

2) Only works with a diversified portfolio. Dollar cost averaging only works when you are investing in a diversified mix of properly allocated assets. Remember that dollar cost averaging is banking on the return of the overall market, and not just one or two stocks. If you only invest in one or two assets, dollar cost averaging will not work.

3) A lump sum can work better. Lets say you inherited $100k. Studies show it would be better to invest the entire lump sum at once, as opposed to streaming it in over time using dollar cost averaging. However, most people don't have a lump sum to invest, which is why we recommend starting with dollar cost averaging in small amounts.

Dollar cost averaging might be right for you if:

Step 1) Open an investing account. The type of investing account you should open will depend upon your goals, but since dollar cost averaging is a long term strategy you could consider a retirement account or brokerage account. You can open these accounts at online brokerages, and even some investing apps.

Step 2) Place investments within your account. You can invest in whatever you like, but remember to focus on building a diversified mix of assets to spread your risk as dollar cost averaging will not work if you only invest in a few stocks. If you don't know how to build an diversified portfolio, you can opt to use a robo advisor which will build a portfolio for you.

Step 3) Set a dollar amount and get started. Once you have your account and portfolio set up, just decide on a dollar amount you want to invest every single month. If you don't have a lot of disposable income, it is ok to start small. It is important to start building the habit of consistent investing so you can compound your returns over time. If you think you are going to struggle to remember to invest every month, you can set up an automatic monthly recurring investment from your bank account.