What if you received a check for $20,000 tomorrow?
How would you invest it?
(And yes, you have to invest it)
You’re not going to let it lose purchasing power by leaving it in your savings account. You’re not addicted to paying down your low-interest debt. You don’t have a child that’s leaving for school in the fall. You have no immediate need for this money. All you want is for this money to grow…so you invest.
But, HOW do you invest it?
For this article, I’m not concerned with WHERE you invest it.
You can put the money into a large-cap mutual fund. You can put the money into a broad-based ETF. You can even put all of your money into Twitter’s stock. I don’t care.
Regardless of WHERE you invest the money, I want to understand HOW you do it.
Please, walk me through this process.
(If you want to know WHERE to invest the money, read this simple advice from Warren Buffett.)
Do you call your Financial Adviser at Edward Jones and tell him to place a trade for $20,000 into the mutual fund? Do you go to the bank around the corner and tell their Investment Specialist you want to put $20,000 into the ETF? -OR- Do you log into your online brokerage account at TD Ameritrade, Scottrade or E-trade, click your mouse a few times and watch $20,000 take a ride on Twitter’s roller-coaster?
The Easiest, Most Common, Most Cost-Effective Way To Invest $20,000
After posing this question to a few friends and co-workers, the most common answer I received was:
“I would log into my online brokerage account and place the trade.”
This is “easiest” because it requires very few steps and it’s something you can do on your own. You don’t need the assistance of a Financial Adviser or Investment Specialist. It’s most “cost-effective” because a Financial Adviser or Investment Specialist is not receiving a cut of the transaction. There’s not a hefty charge for placing trades seen at some traditional brokerages. It’s just a simple $5-$15 to place the trade plus whatever fees are associated with your specific investment (ex. mutual fund), if any.
While this is the easiest, most common, most cost-effective way to invest $20,000, it’s not the OPTIMAL way.
To find out why, let’s take a look at Twitter’s stock.
- If you invested the $20,000 on November 25th, you would’ve purchased roughly 512 shares at $39.06.
- If you invested the $20,000 on December 26th, you would’ve purchased roughly 272 shares at $73.31.
- If you invested the $20,000 on February 5th, you would’ve purchased roughly 303 shares at $65.97.
- If you invested the $20,000 on February 6th, you would’ve purchased roughly 399 shares at $50.03.
What a huge fluctuation!
Depending on which day you chose to invest the $20,000 within a 3-month period, you may have been able to buy 272 shares -OR- you may have been able to buy 512 shares.
If you invested on Wednesday, your investment may be down 20%. If you waited one day to invest on Thursday, your investment may be up 8%.
How are you, an irrational stock picker, supposed to know whether to invest your $20,000 on Wednesday or Thursday?
You can spend 40 hours reading articles geared towards your investment. You can wait until an exclusive report is supposed to be leaked and invest just beforehand. You can befriend someone within the company, wait until they release earnings and invest just before or after the announcement depending on how positive the outlook.
You could “dollar-cost average.”
“Wait, that doesn’t sound very exciting!”
You’re right. It’s not the most glamorous way to invest. But…
It’s the easiest, most effective way to invest $20,000.
How Does Dollar-Cost Averaging Work?
Investopedia describes Dollar-Cost Averaging as:
The technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. More shares are purchased when prices are low, and fewer shares are bought when prices are high.
Dollar-cost averaging lessens the risk of investing a large amount in a single investment at the wrong time.
So, in this case of depositing $20,000 into a single investment, the ideal strategy would be to break up the full deposit into several smaller ones. Rather than “logging into your online brokerage account and clicking your mouse a few times, and watching $20,000 take a ride on Twitter’s roller-coaster,” you would be better off logging into your online brokerage account on the 1st of January and investing $4,000. Then, investing $4,000 on the 1st of February. Then, investing $4,000 on the 1st of March. Then, investing $4,000 on the 1st of April. Lastly, investing $4,000 on the 1st of May.
The decreased risk you’re exposed to by not trying to “time the market” will more than make up for any additional trading costs you’ll incur by placing five trades rather than one.
You’re free to break up the investment into 4 separate transactions, 6 separate transactions or 12 separate transactions. Anything more than this is probably unnecessary.
In closing, the next time someone asks:
“What would you do with a million dollars?”
Tell them you would dollar-cost average (and then tell me how disappointed they look).
If you’re interested in learning WHERE TO INVEST your money, I recommend you read How To Do Better Than Your Friends In The Stock Market With This Simple Advice From Warren Buffett.