Understanding Dollar-Cost Averaging
Putting all your hard-earned money in an investment all at once – thinking it will only go up – can be a very risky idea. But by adhering to a simple strategy known as dollar cost averaging, you will be able to protect yourself against the market rise and fall, and downside risk in the market.
What is Dollar-Cost Averaging?
Dollar-cost averaging (DCA) is an investment strategy of spreading out stock or fund purchases, buying a fixed-dollar amount of a particular investment on a regular interval and in roughly equal amounts. Generally, the investment takes place each and every month, regardless of what is going on in the financial markets. As a result, investors can buy fewer shares when the price of a given investment increases, and they can buy more shares when the price of a particular security decreases.
If the dollar-cost averaging technique is done properly, it could give considerable advantages to investors’ portfolio. This is because the investment technique “smooths” the purchase price over time and helps make sure that investors do not put all their money in at a high point for prices.
DCA can be particularly powerful in a bear market, letting investors buy stocks at low points when most investors are too frightened to purchase. Applying this strategy means that they will be investing when the market or stock is down, and that is when investors hit the best deals.See also Mistakes to Avoid with Dollar-cost Averaging
What are the BENEFITS of DCA?
Aside from its advantage of potentially minimizing the cost per share, dollar-cost averaging has other benefits that you can consider.
1. It Builds Good Investing Habits
Although you are aware of the requirement that you should invest on a regular basis, there are times that you will be tempted to spend the money allotted for investing in other things. If you use regular, automatic contributions, you are less likely to miss the money you invest, more likely to develop investing discipline and more likely to follow your plan.
2. It Exposes you to Opportunities
Market timing, which refers to the strategy of predicting when the market will touch its peak or hit the bottom, and buying and selling accordingly, is almost improbable, even for expert investors. Dollar-cost averaging can help you be prepared to open the door when opportunity knocks.
3. It Lessens Emotional Attachment
With dollar-cost averaging, you get to invest mechanically which can help you eliminate emotional attachment from your decision-making. You will work on a preset course of buying a particular dollar amount of your preferred investment, regardless of how wildly the price swings. In this way, you will not bail out of your investment when the price decline in a wild swing, but rather see it as an opportunity to buy more shares at a lower cost.
4. It is Convenient
It is easy to set up dollar-cost averaging as monthly payment and incorporate it into your budget.See also Presenting the Top Four Events that can Turn your Financial Life Upside-down
The goal of dollar-cost averaging is not to try and time the market, instead, it is to save or invest with amounts of money you can afford. The amount of money that you can invest could be as low as $25 a month or into the thousands. The goal is to help you get into the habit of investing, and dollar-cost averaging gives investors an easy and affordable way to invest money on a regular basis.
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