It’s impossible to find the perfect time to buy or sell an asset. You might think that the price of an asset is already too low, but it can always go lower. The same is true for the opposite direction. When should we invest then?
When we start investing for the first time, we look at the price charts and see the perfect price patterns of tops and bottoms. When we look at the historical price series, we see which asset has returned the most profits. Then we think that it is possible to predict the asset that returns the most profits and the tops and bottoms in the future. This is an example of hindsight bias. In reality, most people can’t predict those facts in the future. So, it doesn’t make any sense to try that.
Not being able to predict those price patterns doesn’t make you a bad investor.
Let’s formulate what we know for sure.
- We can’t predict which asset will bring the most profits in the future.
- We can’t predict which price levels are the top and bottom of a certain asset.
- Your savings in fiat currency like USD and euro will lose their value over time.
The third assumption might strike you. How do I know that for sure, when I can’t be sure about the first two assumptions? I can be sure about the third assumption, because it’s the official policy of central banks and governments to stimulate the economy. It’s not a secret. They say it officially.
What’s the best investment strategy based on these assumptions?
- Build a diversified portfolio that includes stocks, commodities, fixed income assets such as bonds, and even some cash.
- Hold your assets as long as your investment hypotheses holds and you don’t need the money. The more you trade, the more you lose.
- Don’t try to time the market. Average your purchase price over time.
As I have already written two blog posts about the first two parts of the strategy, I will not go into detail of them again. This post is about the third part.
Dollar Cost Averaging
The best strategy to invest your savings in a market is to divide it over time. This strategy comes natural to people who are saving and investing from their monthly paychecks. However, if you already have savings and you want to invest them, dividing them into several installments and investing them over several months can be the better strategy. This is called dollar cost averaging. That way you might avoid losses in case the market goes against you. At the same time, you will be losing some profits in case the market goes in your direction. However, since you know that no one can time the market, you will be fine with whatever direction the market goes.
Let’s summarize all the investment lessons that we have learned so far.
- We know for sure that the savings in fiat currency, USD, euro, and so on, will lose value over time.
- We can’t predict which asset will appreciate the most.
- We can’t predict the bottom and top levels of an asset.
- We can’t time the market, i.e. predict the best time to buy or sell an asset.
Based on those assumptions, the best way to save and invest is the following.
- Start as soon as possible and as small as possible. Learn as much as possible and experiment with free, virtual stock exchanges to gain experience. This is easily one of the top three topics you need to educate yourself in.
- Invest your savings gradually over time, i.e. use the dollar cost averaging method.
- Build a diversified portfolio of various assets, including stocks, index funds, etfs, commodities, fixed income assets, even some cryptocurrencies if you want to take that risk.
- Hold your assets as long as your investment hypothesis holds and you don’t need money. The more you trade, the more you lose.
This post is published for information purposes only and not meant to be investment advice.