April 25, 2022

Dollar cost averaging vs lump sum investing.

Dollar cost averaging is where you pick a fixed dollar amount (usually a percentage of your salary) and choose to invest that amount every single month. It doesn’t matter whether the market is up, down, or flat - you’ll still invest steadily every month.

Lump sum investing is choosing to invest as much money as possible as soon as you get it.

Here’s a side-by-side comparison: two people, let’s call them Jack and Jill, have $6000 to invest. Jill invests $500 per month for a year, while Jack invests his all at once. Jill doesn’t care where the market is at each month because she’s splitting the investment up, thereby minimizing her risk. Jack, since he’s investing all his money at once, may try to time the market and invest whenever he considers to be the optimal time for the year. See where I’m going with this?

The benefits of dollar-cost averaging are mostly psychological. Theoretically, if you can time the market with a decent accuracy, you’ll make better returns on your money. However, most of us can’t do that, and so by dollar-cost averaging your money into the market, you’re building the proper habits and discipline that are required to build a large amount of wealth. If you can commit to investing every month, it eliminates a lot of irrational decision-making that can happen when you focus too much on where the market is at.

How to buy your first house in your 20s

You may think it’s impossible in today’s market, but you’d be wrong. It IS possible to buy your first house in your twenties.

The first thing to have in place is your income. As far as getting a loan is concerned, a W-2 will make it a lot easier than a 1099 - so keep this in mind if you’re thinking of taking your business full-time. If you’re self-employed, a bank will want to see two years of tax returns to verify your income. Most banks will give you a loan of up to 5x or even 6x your salary, but that doesn’t mean you should spend that much on a house. For wealth-building purposes, I recommend a budget of 3x to 4x your salary. This will give you the freedom in your budget to invest, spend on your living expenses, and just have some more wiggle room to work with.

The second thing is your credit score. This is why I recommend starting your credit history early. Even if you’re just paying for gas or groceries on a credit card, you’ll start building up your score. And the difference between a 600 credit score and a 750 credit score, while not earth-shattering, could mean a better interest rate or more favorable loan terms.

The third thing a is your debt-to-income ratio - basically how much money you have coming in each month vs how much you owe each month. Banks will give you a mortgage that costs up to 45% of your monthly income, but that goes down if you’re paying on other loans like student loans, a car note, or credit cards. I recommend keeping your debt-to-income ratio at 25%-30%. You can calculate this by adding up all your monthly payments and dividing by your monthly income. Banks will see other debt, and if it’s too high, they’ll see that you might not be able to pay on all of it at the end of the month.

The fourth thing is getting your savings right. Generally a bank will want a minimum of a 5-10% down payment, and you can’t forget about closing costs, which can be up to 3% of your loan amount. Make sure you don’t overextend yourself and you have the cash on hand to take care of these expenses.

The fifth thing is to think about your life goals and expectations. Make long-term and short-term goals before you make such a substantial investment.

Check out today’s podcast episode below to also hear about these topics, as well as rental real estate tax and the stepped up in basis rule.