The new year had a dismal start for the stock market, with January 2022 being the worst for stocks since March 2020.
The beating some tech stocks took had some investors panic-selling, which is a mistake. Value investors know that buying stocks of companies with solid performance records and holding them for the long-term is the most reliable path to profits.
When an investor sees a drop in the market and sells, losses are locked in. The saying that time in the market beats timing the market is true.
Warrren Buffett once noted that, “whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.” Rather than being a time to sell and run, a stock downturn could be the perfect time to pick up more shares of your favorite high-quality value stocks at bargain prices.
Leaving the stock market entirely typically isn’t a good idea in a volatile market. Volatility may signal that it’s time to re-examine portfolios and goals, though. A downturn is also a time to rebalance to return your portfolio to original asset allocation percentages.
If you can weather the storms of stock market volatility, consider stepping up investments using the theory of dollar cost averaging or value averaging. Here are how these philosophies work.
Dollar cost averaging
Dollar cost averaging is a simple principle. In dollar cost averaging, an investor invests a set amount of money in the stock market on a regular basis, usually monthly or quarterly. Deductions from paychecks that go into a 401(k) account are a form of dollar cost averaging.
The theory holds that regular investment reduces the risk of buying when stock prices are high. Over time, the prices average out, with the investor getting shares at lower prices, which leads to higher profits.
Value averaging
Value averaging is similar to dollar cost averaging, except that new dollar allocations to investments increase when the share price of a particular stock falls and decrease when the share price rises. Value averaging is done by deciding on an amount to invest in the future and investing more on down days, with total investments adding up to that pre-decided amount. It's a balance between dollar cost averaging and market timing, for those who still want to try timing the market but at a reduced risk.
Which is best?
Deciding which way to invest in calm market seas or volatile times depends on your needs as an investor. The pros of dollar cost averaging are that it is simple and can be automated easily, especially in the case of the investor who has funds from each paycheck going into a 401(k) account.
Value averaging, because it involves investing more when a price falls and less when a price rises, can be more complicated. It also involves following stock prices to target those days when a particular equity is a bargain. However, the complexity can be balanced by greater returns.
The bottom line
If you want to passively invest and don’t have a lot of time to spend poring over stock prices, dollar cost averaging is for you. However, if you’re an active investor and want those maximum returns for stocks you’re planning to buy and hold over many years, then value averaging has the potential to increase your returns.
