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Dollar Cost Averaging: What happens if you invest every day?
Dollar Cost Averaging
Have you ever really thought about how kitchen matches work? The strike anywhere kind that you don’t even need the sandpapery strip on the box to light, someone can even light them on their jeans if they fit tight enough. How do they even get hot enough to light?
The match heads contain a compound called Phosphorus Sulfide and they just need the tiniest bit of friction before they light up. Chemists called that friction “activation energy”. Activation energy is the minimum amount of energy that must be provided for compounds to start a chemical reaction, and for Phosphorus Sulfide, the amount of activation energy needed is remarkably low.
As we will see, a lot of other things happen to have a remarkably low activation energy required to set them off as well. Let us say you always wanted to learn to play the piano. You have an old but perfectly serviceable piano in your den, but learning how to play it takes years and it just seems like such a monumental task. So there the piano sits. And sits. Year after year.
Now let’s just say you challenge yourself to play one note per day on the piano. That’s it, literally one single note. So the first day, you sit down, find Middle C, and hit the ivory key. Middle C rings out and now you are done with your required work for the day.
You’ll never stop with the one note though. Since you are already sitting down, you’ll at least try to play a couple chords or scales. So you play a whole C Major chord, and peck away for at least a few minutes.
The next day, you have to play your one note again. So C Sharp this time gets played, one of the black keys. And again you don’t stop there, and you teach yourself another major chord or two.
Months go by and you keep doing that. Your fingers adjust to the chord shapes, you slowly learn the scales and chords, and even how to keep time with both hands. Eventually you will have learned how to play the piano.
Plunking down that Middle C on the first day really had nothing to do with learning all of those individual skills to play the piano, but what it did do was supply the activation energy required to set the whole reaction off. Without it, you never would have started.
All that is required in many important areas of our lives is a little activation energy. Say you want to learn about something that interests you. Again, a monumental task, but just add a bit of activation energy. Commit to reading one word in a book. You know once the book is opened and you read that one word, you will not stop there. It won’t get going by itself, just like that box of kitchen matches won’t spontaneously combust, but a little activation energy will set it all off.
So read a book on a subject, it’ll take about a week, a couple chapters every night. Now keep doing that and read about fifty books a year. If you read that many books in one year about the same subject, you will literally be among the most qualified and knowledgeable experts in the entire world on that subject. Think about it. How many people have read fifty books on plate tectonics in the entire world? Not many, but you could in a year.
Now let’s use that metaphor with saving money. If you are living paycheck to paycheck, saving up a million dollars seems as overwhelming as learning the piano or becoming a world renowned expert on plate tectonics. But just put a little activation energy into it. Save up five dollars a day. That’s it, just five bucks. Everyone can scrounge up five bucks a day.
Do that for a month and now you have one hundred and fifty dollars, another month and you are up to three hundred. Now start putting half into an index fund or something and half into a savings account. Now it’s starting to grow a bit, albeit slowly.
But it's just fine that it's growing slowly. I think you see where this is going by now. Can you get rich by saving five bucks a day? Not really. Just like you can’t learn to play the piano by plunking Middle C once a day. But saving five bucks is the activation energy you need to set the whole thing ablaze.
You’ll gain a little momentum. The savings account is growing, and your index fund is growing even a bit faster. You are not going to want to stop at five bucks a day. Now you have built the habit, you like what you are starting to see and you will want to bump it up to ten dollars a day. You will want to.
Now it’s growing twice as fast. More than twice as fast actually because of compound interest. Soon you will have a few thousand dollars saved up. That may seem like a lot now, but that’s about the equivalent to learning how to play Twinkle Twinkle Little Star on the piano. Who would do that just to stop there though? You want to learn how to play Beethoven, or at least a couple of Elton John bangers. And since you put the activation energy into it, you are on your way. It literally takes more effort to blow out the match now than to just let it burn.
Dollar cost averaging. Challenge yourself to saving a few bucks a day and reading a few pages in a book each night. Just do that for three weeks and see what happens.