DRiP Primer

Benefit From Market Volatility

If you are like many of the investors that we talk to on a daily basis, recent market volatility has probably sent scurrying for a dose of Dramamine. If, however, you are like many good DRiP investors who focus on long-term investing and dollar-cost averaging into stocks, you should hope for more volatility like this in the future.

Looking at stock market data dating back to August 2008 – the beginning of the last stock market crash, it’s easy to see that investors focusing on DRiPs can benefit from market volatility. Consider the following three scenarios for a representative $10,000 portfolio.

Scenario A: Investor sells all of his stocks & stops dollar-cost averaging

In scenario a, we have assumed that the investor sold all of his stock holdings on August 10, 2008, stopped investing and held only cash through August 16, 2011(three years). Obviously, this investor would be no better, or worse, off than he was in August 2011. He would still have $10,000 and would have avoided an extreme amount of market volatility over the years.

Scenario B: Investor holds all of his stocks & stops dollar-cost averaging

In scenario b, we assumed that the investor held on to all of his stock holdings, but stopped his monthly investment contributions through August 16, 2011. This investor would actually be worse off than he was in August of 2008. The analysis shows that this investor would have lost 8.6% of the value of his portfolio which would now be worth only $9,138. This investor would have been better off had he followed scenario and sold all of his holdings in August 2008. However, the investor in scenario c (below) comes out on top of them all.

Scenario C: Investor holds all of his stocks and continues dollar-cost averaging

We assumed that this investor held all of the stocks that he owned in August 2008, but this investor continued to invest $100 per month into his portfolio. We found that this investor’s portfolio would have increased in value by an amazing 31.7% and would now be worth over $13,170. That return would have outperformed the S&P 500 by 40.3 percentage points. That kind of performance could land you a very highly paid job on Wall Street.

So, how did this happen? During this time, the S&P 500 fluctuated between approximately 720 and 1,370. Therefore, during times of low market prices, the investor’s $100 investment purchased more stock. During periods of high market prices, the investor’s $100 investment purchased less stock. Those investments that were purchased when the S&P 500 was near its lows in 2009 had nearly doubled in value over the ensuing months/years.

The takeaway here is that “buy-and-hold” isn’t necessarily a bulletproof strategy for investors. Scenario 2 was the typical “buy-and-hold” investor and his portfolio performed the worst. It would appear that a strategy of “buy-and-continue-to-invest” would be better suited for those who want to profit from market volatility and uncertainty. Just be sure to do your homework and invest in the right companies.

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