UBS’s Art Cashin rang the opening bell on the New York Stock Exchange to mark his 50th year trading on Wall Street.
So, what kind of wisdom does this veteran have for us after all that he’s seen?
He shared a time-tested strategy in an interview on CNBC:
“…one of the key things that people can do, particularly if they’re starting their investment plan, there’s something called dollar-cost investing, in which you set aside a certain amount of money, $200, $500, and you buy it every specified day. Every month, or every six months. And that way, if stock prices are down, you wind up with more shares, and if stock prices are too high, you don’t buy as much. So, dollar-cost averaging works out pretty well, and yes, the stock market continues to be a good investment.”
Cashin said this even as the S&P 500 was trading within points of an all-time high.
The brilliant thing about dollar-cost averaging is that it works very well even if the market is at a top.
We ran the numbers to see how an investor would’ve done had she started a dollar cost-averaging strategy right before the last market crash.
There’s A Correct Way To Buy Stocks If You’re Convinced The Market Will Crash
The stock market is great for investors who have the benefit of long-term investing horizons. It’s also better-suited for investors who aren’t concerned about perfectly-timing market tops and bottoms.
Having said that, taking a longer term view is good for investors worried that they may be buying at the top of the market.
A classic strategy called dollar-cost averaging can help reduce risks surrounding an asset falling in price. As described by Cashin, the concept is straightforward — you invest a fixed amount of money in an asset once every fixed time period. If the asset’s price drops, you will be getting more shares of the asset for the same amount of money, and so if and when the price recovers, you will have spent less per share, on average, than if you had bought the shares at their peak, pre-fall price.
Dollar-cost averaging isn’t about losing money as the stock market falls. It’s about buying increasing amounts of shares at cheaper prices, which means bigger returns during the rally.
How Dollar-Cost Averaging Worked Brilliantly During The Last Crash
To see this in action, we came up with a simplified thought experiment.
We considered what would have happened to an investor jumping into the stock market at the last peak: October 2007. This was arguably the worst time to buy. Our hypothetical investor puts $50 into a S&P 500 index fund at the start of every month, starting in October 2007 — the last stock market peak before the beginning of the great recession.
Here is what happened to the S&P 500 starting at that peak:
The index dropped more or less steadily until the worst moments of the financial crisis in fall 2008, causing the full on crash, and only began to turn around in March 2009.
The key to our investor’s experiment is that they are staying consistent. No matter how stock prices move, they will always put $50 on the first trading day of every month into the index fund.
Based on changes in the value of the S&P 500 index, we calculated our investor’s price return, less the $50 monthly cost:
The value of our investor’s portfolio as of December 1, 2014 is $6,896.30. If they instead had taken their $50 each month and held it as cash, they would have just $4,350. So, the price return on this investment — even though they started at the last peak, just before the market started to go downhill — is $2,546.30.
This is a respectable 58.5% return. That averages out to about a 6.6% annual rate of return.
To get another perspective on this, here is the percent gain or loss, compared to taking $50 each month and holding it as cash:
Things start out looking pretty dire, as the economy fell into its deep recession through mid-2009, with the S&P 500 reaching a minimum in March of that year. At the lowest point for our investor, at the start of February 2009, she would be down about 36%.
Because human beings are often overly risk-averse, our hypothetical investor might have been tempted to abandon their investment plans during the bad months. That is, they might look at this chart and panic about the drop:
But, if our investor sticks with their plan and keeps putting $50 in every month, even through the dark times, once the market bounces back, they end up doing quite well:
Here’s Why You Never Hear About This
Unfortunately, dollar-cost averaging isn’t sexy. It’s much sexier to sell at the top and buy at the bottom.
Obviously, your returns would be much higher if you win the stock market lottery by perfectly timing the tops and bottoms of the market. However, almost everyone who tries to do this will find themselves losing money and lots of it.
If you are investing for the long haul, and can hang on through watching your portfolio’s value drop temporarily in bad times, starting to invest in stocks, even near a peak, may not be as terrifying as it looks. The market has always bounced back sooner or later, so if you can hold on until that later, don’t panic.
Gambling is defined as staking something on a contingency. However, when trading is considered, gambling takes on a much more complex dynamic than the definition presents. Many traders are gambling without even knowing it – trading in a way or for a reason that is completely dichotomous with success in the markets.
In this article we will look at the hidden ways in which gambling creeps into trading practices, as well as the stimulus that may drive an individual to trade (and possibly gamble) in the first place.
Hidden Gambling Tendencies
It is quite likely that anyone who believes they don’t have gambling tendencies will not happily admit to having them if it turns out they are in fact acting on gambling impulses. Yet discovering what drives us to take certain actions can create change within us as the underlying motivators are discovered by the conscious mind.
Before delving into gambling tendencies when actually trading, one tendency is apparent in many people before trading even takes place. This same motivator continues to impact traders as they gain experience and become regular market participants.
Some people may not even have an interest in trading or investing within the financial markets, but social pressures induce them to trade or invest anyway. This is especially common when large numbers of people are talking about investing in the markets (often during the final phase of a bull market). People feel pressured to conform by their social circle. Thus they invest so as not to disrespect or disregard others’ beliefs or feel left out.
Buying some stocks or placing some trades to appease social forces is not gambling in and of itself if people actually know what they are doing. But entering into a financial transaction without a solid investment understanding is gambling, regardless of what the social media portrays. Such people lack the knowledge to exert control over the profitability of their choices. There are many variables in the market, and misinformation or disinformation within investors or traders creates a gambling scenario. Until knowledge has been developed that allows people to overcome the odds of losing, gambling is taking place with each transaction that occurs.
Contributing Gambling Factors
Once someone is involved in the financial markets, there is a learning curve, which based on the social proofing discussion above may seem like it is gambling. This may or may not be true based on the individual. How the person approaches the market will determine whether she/he becomes a successful trader or remains a perpetual gambler in the financial markets. The following two traits (among many) are easily overlooked but contribute to gambling tendencies in traders.
Gambling (Trading) for Excitement
Even a losing trade can stir emotions and a sense of power or satisfaction, especially when related to social proofing. If everyone in a person’s social circle is losing money in the markets, losing money on a trade will allow that person to enter the conversation with her/his own story. When a person trades for excitement or social proofing reasons, it is likely that she/he is trading in a gambling style rather than in a methodical and tested way. Trading the markets is exciting; it links the person into a global network of traders and investors with different ideas, backgrounds and beliefs. Yet getting caught up in the “idea” of trading, the excitement, or emotional highs and lows is likely to detract from acting in a systematic and methodical way.
Trading to Win, and Not Trading a System
Trading in a methodical and systematic way is important in any odds-based scenario. Trading to win seems like the most obvious reason to trade. After all, why trade if you can’t win? But there is a hidden detrimental flaw when it comes to this belief and trading. While making money is the desired overall result, trading to win can actually drive us further away from making money. If winning is our prime motivator, the following scenario is likely to play out: Jill buys a stock as she feels it is oversold compared to the rest of the market. The stock continues to fall, placing her in a negative position. Instead of realizing that the stock is not simply oversold and that something else must be going on, she continues to hold the position, hoping it will come back so she can win (or even break even) on the trade. The focus on winning has forced the trader into the position where she doesn’t get out of bad positions, because to do so would be to admit she lost on that trade.
Good traders take many losses; they admit they are wrong and keep the damage small. Not having to win on every trade and taking losses when conditions indicate they should is what allows them to be profitable over many trades. Holding losing positions after original entry conditions have changed or turned negative for the trade means the trader is now gambling and no longer using sound trading methods (if she/he ever was).
The Bottom Line
Gambling tendencies run far deeper than most people initially perceive and well beyond the standard definitions. Gambling can take the form of needing to socially prove one’s self, or acting in a way to be socially accepted, which results in taking action in a field they know little about. Gambling in the markets is often evident in people who do it mostly for the emotional high they receive from the excitement and action of the markets. Finally, not trading in a methodical and tested system, but rather relying on emotion or a must-win attitude to create profits, indicates the person is gambling in the markets and unlikely to succeed over the course of many trades.