INVESTINGLIFESTYLE & TRAVELBUDGETING

Dollar-Cost Averaging: Make Your Dollar Work for You

Investing can feel like a roller-coaster ride for your emotions, experiencing the highest of highs and the lowest of lows. This can cause people to buy and sell investments based on how they feel. Some people tend to look at investing as a short-term game. They will look at all their options and attempt to make the most money in the least amount of time.

Often, people will buy all their investments at once as opposed to buying over a longer duration. It’s easy to look at a stock or asset as a “buy now” opportunity, but spreading out your money over time and investing consistently could lead to more shares and a better return on your investment as opposed to dumping all your money in at one price point. Instead of investing over the short term, try thinking of investing as a long game, with the objective of profiting off returns year after year while consistently reinvesting.

Investors can do this through dollar-cost averaging.

What is Dollar-Cost Averaging?

Dollar-cost averaging, or DCA, is an investing strategy where an investor puts the same amount of money into a security consistently over time. The concept behind DCA is to strategically use your money to avoid timing the market. Many investors will attempt to time the market and buy at the “best” possible time when a share is low to maximize profits. This can cause investors to make quick decisions and potentially lose out on long-term returns.

Example of Dollar-Cost Averaging

An example of a DCA investment would be a 401(k). Regardless of the market standing, employees continue to contribute a dedicated amount to the account from each paycheck.

DCA investors often accumulate more shares of a stock over a longer period of time as the stock market goes up and down. When you invest a lump sum all at once, you’re locking in that price point. In comparison, the advantage of DCA is you can invest over time at different price points.

As another example, let’s say Sam invests $500 in the stock market at $12 per share. Sam would own 41.6 shares of that company.

Now, let’s say Bill spreads that $500 over the course of five weeks, contributing $100 per pay period to the stock market.

Week 1-Stock Price=$12 | Shares=8.3

Week 2-Stock Price=$10 | Shares=10

Week 3-Stock Price=$10 | Shares=10

Week 4-Stock Price=$13 | Shares=7.69

Week 5-Stock Price=$12 | Shares=8.3

After five weeks, Sam would own 44.29 shares of the stock for the same amount of $500 using the DCA investing method.

Benefits of Dollar-Cost Averaging

• It can lower the average amount spent on investments.
• It creates a habit of investing regularly.
• Automatic transfers allow for passive investing.
• It takes emotion out of investing.

Disadvantages of Dollar-Cost Averaging

• It’s a conservative approach.
• Prices could consistently rise over time, leading to fewer shares.
• A hands-off approach could limit opportunities for bigger profits.

Overall, the dollar-cost averaging method is potentially a way to consistently be involved in the stock market without taking a big risk. It also creates a habit of investing, like putting a set amount into your savings account. It removes the emotion and gambling aspects of investing, allowing you to play the long game.

Sources:

https://www.investopedia.com/terms/d/dollarcostaveraging.asp

https://www.schwab.com/learn/story/what-is-dollar-cost-averaging