Recently I came across an advertisement from the American Funds Group, stressing the value of pursuing a long-term investment strategy instead of constantly trying your hand at market timing.

Market timing

Just in case you don’t know, market timing is the strategy of attempting to predict future price movements through use of various fundamental and technical analysis tools, with the intent of taking advantage of said movements. For example, if you can figure out if/when a stock is going to take off, your returns are going to be much higher than those of the investors that catch that stock on its way up. Conversely, if you can tell if/when a stock is going down, you can get rid of it and avoid losses (or even short it and laugh all the way to the bank). But as most investors know, market timing is elusive at best and can turn out to be quite dangerous, because stock prices don’t always follow the most logical or easily predictable paths.

This is the main reason why there’s quite a controversy about market timing as an investment strategy. Many investors believe that over time it’s impossible to predict market movements (the efficient market theory). So to them, market timing is more of a gamble than a legitimate investing strategy. Many of them advocate another investing strategy called dollar cost averaging,

Dollar cost averaging

Dollar cost averaging is the practice of investing or saving money at specific times, regardless of market conditions or your personal financial outlook. It’s not the sexiest strategy out there, and you won’t be making headlines by pursuing it, but many studies have shown that this method actually works very, very well. And as you’ll see, it’s one of the reasons why you can perfectly get rich with your 401k.

Louie The Loser

Analysts at Capital Research and Management Co., a mutual fund, created a fictional character and named him Louie The Loser. The reasoning behind the name was that they’d create an investor who practices dollar cost averaging, but is unlucky enough to invest his money every year at the worst possible time: on the day that the Dow Jones Industrial Average hits its peak for the year. The data I found covered the 20-year period between 1978 and 1997. So how did Louie fare?

As it turns out, Louie was hardly a loser. After 20 years, Louie’s total $200,000 investment had turned into more than $1 million, growing at an average rate of 15.7% per year. The most startling part of the story is that if he had picked the best day each year to invest (which would be the day when the Dow Jones Industrial Average is at the lowest for the year), he wouldn’t have fared THAT much better, because his return would have been 17.2% a year.

What you can learn from Louie is that while there is no doubt that there are good times and bad times, in the long run any day is a good day to invest. If you’re new to this whole investing thing, your stock market for beginners education should just be to understand dollar cost averaging (eventually, you’d move on to other investing techniques). It’s no wonder that successful investors like Warren Buffett recommend ignoring the day-to-day variations of the market, instead advocating a simple buy-and-hold strategy for long term investing.

Louie The Loser: A Dollar Cost Averaging Success Story

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