This will be a post oriented toward beginners who want to start investing, or have just started and are looking for advice on how to build their portfolio.
So the eternal question is what do I buy? and what if it goes down right after I buy in? And it doesn’t matter if you’re planning to buy an index fund or a specific stock, the question is the same.
And the answer isn’t to wait till whatever it is goes down and then buy it, because timing the market doesn’t work. Many people have waited years for a market correction to go in, and missed out during that time on great returns. In general, time IN the market more important than timing the market (ie waiting for what looks like a good time to get in). This is also because whenever it is a good time to buy in (for example late March 2020), in the present it feels scary and smarter to wait for it to “go down more”, or start going up. Most people don’t like to “catch a falling knife”. Whoever wasn’t invested in Feb 2020 and waited for a time to invest, if they blinked beyond April, they missed their opportunity, because NO ONE expected such a fast return.
So the simplest method is just to buy whenever you have money to invest and hold. Buy an index (or a company/few companies you like) and forget about it for 20 years.
This isn’t a horrible method, and history says that if you do that, you will make money. The problem is that how much money you make can vary very (!) drastically. Lets look at the graph of the nasdaq since the year 2000 for example:
If you bought in 2000 and held until 2020, you made money. Specifically, lets say you bought in 2020 at 4000 and held until 2020 at 8000, you made 100%, so you doubled your money over 20 years, for a return of ~3.5% compounded annually. If you bought in 2002 and held until 2022, you bought at 1600 and held until 2022 at 15000, so you made 930% (!), or a return of ~12% compounded annually. And granted the dot com crash of 2000 was a rare occurrence, but looking at the above graph, it isn’t impossible to think that there could be another drawdown of 30-60% from where we were at the end of 2021, making now a singularly inopportune time to put all your money in the stock market.
To avoid such a situation, a popular (and successful) method is dollar cost averaging. Here is a more detailed explanation, but it basically means taking the amount of money you have to invest now and, instead of investing right away, dividing it up and investing it in increments over a predetermined period of time. The strategy works for opening a position on an index as well as opening a position on a specific stock.
Lets look again at the case of 2000. If instead of putting all your money in at the same time you dollar cost averaged in from 2000 over the following 3 years, so from 4000 to 1000 (in 2003), your average purchase price would actually be just about 1660, enabling you to get the 900+% return over the following 2 decades.
To see the disadvantage of dollar cost averaging, lets say you’re starting to invest in 2016. When the index (or stock) you’re buying only goes up throughout the dollar cost averaging period, the average purchase price is higher than if you had bought at the beginning. Nonetheless, you make money, so generally you wouldn’t complain about missing out on potentially more money when you are still making money.
A slightly better method and one of the strategies that I use, if you are willing to take a bit of time and learn a tiny bit about options, is selling puts. I wrote an entire post about the strategy and how it works here, and despite that it involves doing options, its a super simple, set and forget strategy, which can be highly successful in building a long term portfolio.
Let me know which strategies you use to build your porftolio, down here in the comments.