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The 3.4% loss for the Dow Jones Industrial Average after Britain voted to leave the European Union was certainly ugly to see. The market doesn't like uncertainty, which leads to selling. Since the impact of the Brexit is not clear, investors used this news to sell equities. Despite the negative market sentiment, most investors should maintain a dollar-cost-average [DCA] strategy and stay focused on the long-term.
It is natural for investors to want to do something as a reaction to the Brexit situation. If you are dollar-cost averaging in a 401k, 403b, or other retirement plan, you are already doing something and no other action is really necessary.
By taking a certain percentage out of your paycheck on a regular basis and putting it into a retirement plan, you are buying new shares at discount prices when the market falls as it did recently. When the market rises again, you will be benefiting from the price appreciation, which compounds your savings.
Equities are the best asset class over the long-term. However, you have to keep a cool head during the downturns to benefit from the upside. If you sell into the negative sentiment, you are likely to have trouble jumping back in at the right time. Therefore, you are likely to experience higher losses by trying to jump into or out of the market at the right time. Dollar-cost averaging takes the guesswork and emotion out of investing. DCA allows you to keep adding to your savings, buy stocks at a discount when the market falls, and ultimately benefit from a rising market over the long-term.
I think that one of the key aspects to the DCA strategy is the savings component. Investors who get scared out of the market might stop putting money into their retirement account. If you are putting 10% of each paycheck towards retirement, being out of the market for a year would mean that $5,000 on a $50,000 salary or $10,000 on a $100,000 salary would not be compounded into your savings every year. It is the discipline of saving on a regular basis plus the compounding effect of price appreciation that will get investors to their goal of having enough money to retire with a level of comfort.
Critics of the DCA strategy point out poor returns of the S&P 500 over a certain time period. The critics say why dollar-cost average when the returns have been so poor over the past 16 years. Granted, the S&P 500 did not perform as well since 2000 as it did for the 16 years from 1983 through 1999. For example, the S&P 500 only provided an average annual return of less than 3% since 2000 due to the bursting of the dotcom bubble and the 2008 financial crisis. This was much less than the market's historical annual return of 10%. However, if a person was still saving 10% of their earnings over the 2000 to 2016 period, what else other than equities would you have invested in?
The gold bugs usually chime in and say how great the yellow metal has performed since 2000. The price of gold did significantly outperform the stock market from 2000 through 2016. However, the price of gold significantly underperformed the stock market from 1983 through 2000. Gold also underperformed the stock market over the entire period from 1983 to 2016. So, gold is OK to own as a hedge as a small percentage (under 10%) of your portfolio, but it is not a viable alternative to investing in equities over the long-term.
I think dollar-cost averaging into a diverse mix of stocks and bonds is the best strategy for most investors. Use the proper asset allocation that is appropriate for your age group or years until retirement. This will ensure that you have the proper risk/reward for your age.
For those who insist on doing something based on the current uncertainty in the market, there are a few alternatives that you can employ. You can buy a put option on the S&P 500 to act as insurance against your portfolio. You'll make money if the market falls below the strike price that you buy at the expiration date. For example, consider buying the SPDR S&P 500 ETF (NYSEARCA:SPY) $203 put at the October 21 expiration. You'll profit if the ETF is trading below $203 by October 21. If the ETF trades above $203, then you'll lose the entire price that you paid for the put (about $850). However, if the market falls significantly by expiration, you could make a high return, possibly doubling your money.
Another strategy is to sell call options against your stock positions. I covered this strategy in the following article. You can sell 1 call option for every 100 shares of individual stock that you own. The premium that you sell is credited to your account. This is like paying yourself extra dividend payments. The risk with this strategy is that you could have your position called away if the stock rises to the strike price that you sold.
If you own individual stocks outside of a retirement account, then you could add to your positions as the prices decline. If your thesis remains intact for owning these businesses, then the sell-off in the market will create an improved valuation. So, by purchasing more shares, you are lowering your cost basis.
The options strategies are for the more savvy investors. Most investors should stick with a DCA strategy and keep an eye on the long-term. Economic uncertainties and recessions will come and go. The important thing is that by sticking with DCA, you'll benefit over the long-term and have enough money to retire comfortably.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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