What Is Dollar Cost Averaging and Why It Doesn’t Work in Retirement

When markets are down, there are two types of investors. Those licking their wounds and those licking their chops. If you are in the former category, seeing your portfolio right now might be painful. If you’re licking your chops, you understand the recent gains were only on paper. You still believe stocks over time will outperform. And you still may have years of investing left.

Do you still have time if you are near or in retirement? When you are in your final years of work, what time do you have? For savers who have time, they have the benefit of dollar cost averaging. If you make regular investments over time, and markets go up and down in the short term, your average ‘cost’ is lower than the average ‘price.’ When you buy the same dollar amount at a lower price – like when markets are down – you buy more shares compared to when prices are higher. The greater number of shares you bought at that lower price are on average lower than the smaller number of shares when prices are higher. If this is you, you shouldn’t be concerned when markets drop. As long as your investments are aligned with your goals, history favors staying with your plan.

When you are retired, however, the opposite can happen. If you need $1,000 and the price to sell your investments are lower, you need to sell more shares. That means you have less shares left to work going forward. That is why it is important to set aside a ‘bucket’ of cash to meet your upcoming expenses. I manage portfolios to keep between 12 to 24 months of expenses set aside in cash for this reason.

The stock market’s volatility is also a reason to own bonds. They pay a regular income and are relatively more stable. “But, Bud, bonds are down just as much as stocks and interest rates are low!” Yes, bonds are seeing one of the worst periods right now. They offer a return of principal with interest over time. They are generally safer than stocks, which offer no promise to return your capital. However, with the recent upward move in interest rates, lower yielding bonds are less attractive and therefore their prices have gone down.

Are we at a point where interest rates will stabilize, and stocks will start to move up? Who knows what the next year will bring, but I do know stocks are less expensive and interest rates are higher than they were at the start of the year. I believe your investments should be spread across stocks and bonds in a manner that matches your needs, your time, and your comfort with taking risk.

But what about inflation? And what about rising costs in retirement?

As a rule of thumb for retirees, if you withdraw between 4 to 5% of your investments each year, this should last you a lifetime. Studies of past markets, inflation, and longevity give a high chance of success – in other words, not running out of money before running out of breath.

What works for you? Let’s take a deep dive into your situation and find out what resources you have, whether it’s your work, your portfolio, or a combination of both. Let’s also look at what impact inflation is having on your future expenses. Knowing how ready you are for financial freedom can be empowering and motivating given the right tools, insight, and steps to get you there.