An often overlooked element of investing into index funds… well, investing in general really, is actually how often you should be investing. Should you put everything in all at once? Little bits every day? Every month? Annually?
Generally, you should look to invest into an index fund every month. The reason for this is you will be utilising dollar cost averaging. Essentially, you reduce the impact of investing everything at a point where the market is too high.
‘Great! I now know how often I should be investing – that’s everything I need to know about that… right?’ Well, there are a few more nuggets of information that will help you make sure you’re getting the most out of these investments.
A Bit More On Dollar Cost Averaging
Based on the explanation above, I feel like I owe you some extra information on dollar cost averaging – what exactly is it?
By definition, dollar cost averaging is ‘an investment strategy in which an investor divides up the total amount to be invested across periodic purchases of a target asset in an effort to reduce the impact of volatility on the overall purchase.’… So what does that even mean?
Think of it this way… you have £10,000 to invest and you’re debating whether to invest it all in one lump sum, or invest it evenly over a period of months (then continue to add to it on a regular basis) – what should you do?
Well, anyone with a brain would think ‘well if I don’t invest it now, it’s just going to be sitting in my bank not doing anything – I should just invest it now’ – and I see that logic. However, no-one can predict what the market will do next.
If the market is at a high point, by investing all of your cash you are just going to be devastated when the market comes back down again. Dollar cost averaging is kind of what it says on the tin – it averages out the dollar cost of your investments.
Say you buy 100 shares for £10,000 – when the market goes down over time, you’ll end up buying another 100 shares for £9,500, then more at £9,000 – if we look at the average cost of all 300 of these shares, it will be £9,500. However, if you were to have invested all of your money in the first month, you’d have a higher average cost at £10,000 – see the benefit?
Now, you could argue that if the market is low, you’re better off putting all of your money in now so that you’re not buying at higher price points in the future…. That’s correct, but not necessarily sound advice. We mentioned earlier that NO-ONE can predict how stocks will move – the best approach is evenly spread investments over a regular period of time in the face of uncertainty.
I first read about this in this AMAZING book called ‘The Intelligent Investor‘ – it’s recommended by Warren Buffet, the absolute godfather of investment.
[Wow, that was a big section…]
How much to invest each time
Now we’ve hashed out how often you should be investing into your chosen index fund, let’s take a look at how much you should invest each time.
As a rule of thumb, you should only be investing (overall) money that you can afford to live without each month. Should you have had all of your money invested around March 2020 (when COVID started gaining momentum), you’d have been having a super bad day.
The answer for how much of this should be investing each month into index funds in particular is… well, it really depends. If index funds make up a small chunk of your portfolio (say, 10%), I’d say that you should only invest 10% of the available money you have into these index funds.
I only say this because if you’ve got a nicely structured, well diversified portfolio – investing any more than 10% might knock out the balancing of your portfolio and leave you over exposed in a certain area.
When to stop investing
Now you should be equipped with the knowledge of how often you should be investing into your index funds and how much money you should be investing each time.
Well, obviously you can’t keep this going forever – there is going to come a time that you want to stop ploughing your money into investments. This could be for a number of reasons – if you want to learn more about this, check out my ‘Investing – Why Isn’t It For Everyone’ article to find out why. In general, it’s just a change in lifestyle – having a baby or paying off a mortgage, that sort of thing.
Regardless of the reason you want to stop investing, here are a few things that I’d consider whilst making the decision:
- Do I need to completely stop or should I just withdraw enough to fund whatever it is I’m looking to do?;
- Do I still enjoy it? – personally, I love looking at how investments move each day and trying to figure out what has caused the movements (i.e. recent news published); and
- What are the costs vs benefits of stopping investment.
Planning your exit strategy
You’ve decided now is the time to stop investing – what should I do about all of the money that I’ve currently got invested?
Now is the time to be thinking about your exit strategy. All that an exit strategy is, is a method in which you decide to sell everything so you have all your money back.
The majority of people would just think to sell everything at once – after all, I could really use the money NOW, right?
Well having a well planned and executed exit strategy could allow you to walk away with more money than that of if you’d have sold up everything at once.
Now there are only two ways you’ll ever exit an investment:
- At a loss; or
- At a gain.
The investments that have performed well and are at a gain, go ahead and sell them to lock in that sweet sweet gain. However, those that are currently at a loss, just have a careful think about:
- Why have they dropped – is it just because the market’s low and is likely to rebound?;
- Has there been some news on the specific company that the index funds is heavily invested in – is this news temporary?; or
- Has the index fund really gone down hill and it’s a super long shot to get your money back…
To the first two points, my advice would be to wait for the market to even out and take the investment at cost or even wait for a small gain depending on how urgently you need the money.
The final point – I would just cut your losses and take the hit. By staying in longer, you give more people the opportunity to jump ship and your loss continues to increase.
Summary
To nicely round this article off, let’s recap everything we’ve covered:
- It is best to invest into index funds roughly once per month;
- Only invest as much money as you can afford to lose;
- When considering whether to stop investing – ask yourself a few reasons why; and
- Ensure you have an appropriate exit strategy to ensure you are walking away with the maximum amount of money as possible.