As you invest more deeply in investment, you might come across the term dollar-cost averaging. DCA investing is designed to make lump-sum investments over time and an alternative to lump-sum investment. You may want to give it a try. In this article, I will describe what it is and then examine dollar-cost averaging benefits.
What is dollar-cost averaging (DCA Investing)?
When you’re dollar-cost averaging, you are committing to a strategy in which you invest your money at regular time intervals. Instead of making a large lump-sum purchase, you will buy smaller amounts over time.
For example, this strategy results in more capital being invested when the markets are low and fewer funds being invested when the market is high. In contrast to an lump-sum investment plan, this method instead involves buying a fixed quantity of stock at specific points during the buying and selling process.
In other words, DCA investing generates both high and low sales prices, which provides an opportunity for spreading out risk. Dollar-cost averaging could be useful in volatile market conditions.
Example of dollar-cost averaging
Here’s an example of dollar-cost averaging to illustrate this investment strategy.
Maybe you have a 401(k) in which you set aside part of your paycheck every month. You can use your 401(k) funds every pay period. Consequently, sometimes your costs are low, and sometimes they’ll go higher. Over time, however, the average of your out-of-pocket expenses will be averaged, leading to a better overall investment.
Below is a hypothetical example showing lump sum versus dollar-cost investing over four months.
Lump-sum purchase price: $10,000
DCA Investing: $2,500 per week
In this example, the lump-sum investment only purchased 200 shares for $50 each. However, by using DCA, the price average was $47.50, and over the course of the four months purchased 213 shares. This is only an example to show again.
Of course, there is still the chance that you may have done better with a lump sum purchase. However, typically, dollar-cost averaging spreads out risk.
Dollar-cost averaging benefits
Now that you are aware of a little more about dollar-cost averaging let’s look at the benefits to having a dollar-cost averaging portfolio. You may be surprised at how much this strategy could improve your own investment portfolio.
Reduces risk
One of the major dollar-cost averaging advantages is the opportunity to reduce your risk over time. By dollar-cost averaging, you will be able to build up your portfolio at a steady rate. Instead of making an immediate investment, you can spread your money out over a longer period of time.
As a result, you can decrease losses and potentially gain higher returns. In addition, you will have minimal risk in your portfolio.
Is lower cost
Dollar-cost averaging gives you more bang for your buck during your investment strategy. And during the course of the process of your investment strategy, you might be able to purchase more shares at a cheaper price. If you had invested a lump sum at a high point in the stock market, you would hold fewer shares.
Enables habitual saving
However, if you want to get the best results from dollar-cost averaging, you need to set aside a fixed amount of money for your savings fund and make regular deposits. In addition, you should regularly add to your investment account. Hopefully, these regular contributions will remind you of your financial goals and help you attain them.
Avoids market timing
Experts suggest that timing purchases so that one can buy low and then sell high can beat the market. However, the majority of investors are unable to keep pace with the market’s returns.
Dollar-cost averaging prevents you from timing the market or chasing bear and bull markets. Instead, you will make regular investments over time. Possibly beat the competitions’ timing standards.
Handles the emotional component of investing
It can be difficult to part with large sums of cash when building an investment portfolio. Investing involves risk. It is also difficult to put your money at risk.
Fortunately, dollar-cost averaging can help. The strategy involves dividing your money into smaller chunks. It can be simpler emotionally to prepay $2,000 at a time rather than paying $10,000 at once.
Everyone must manage the emotions associated with investing. It can be difficult without a sound comprehension of your risk tolerance. Not sure where you stand? Take the risk tolerance quiz on our website.
Dollar-cost averaging drawbacks
As with every major financial decision, there are drawbacks to making an investment in DCA. Here is what you should carefully consider before making such a significant investment.
More transactions
A clear problem with dollar-cost averaging is that you’ll have to produce more transactions. And more importantly, the transaction fees can add up fast. You can solve this problem by working with a brokerage firm that offers discounted investment opportunities.
Tricky to realign asset allocation
As you invest, you’ll want to keep your asset allocation in order. Essentially, that means you’ll need to make certain that your investments constantly reflect your goals and risk tolerance.
It can be difficult to keep things in line with dollar-cost averaging. However, as a careful investor, you can realign often to keep your portfolio on track.
Need a long-term commitment to investing
Dollar-cost averaging will require you to regularly purchase additional investments. The need to frequently add to your portfolio can be difficult for some to keep up with. In other words, if you are interested in investing in 1965, you must be willing to make a long-term commitment before diving in.
Dollar-cost averaging calculators to try out
Check out these free dollar-cost averaging calculators to see how dollar-cost averaging might affect your investment plans.
Dollar-cost averaging calculator from Merrill Lynch
This simple dollar-cost averaging calculator from Merrill Lynch is also easy to use. It highlights the advantages of regular investment with this plan.
Dollar-cost averaging calculator from Buy Upside
This calculator from Buy Upside is a slightly more complicated version of a DCA calculator. It allows you to calculate dollar-cost averaging based on investments in individual stocks. This can be helpful for someone making a broad portfolio that contains many items.
Bitcoin dollar-cost averaging calculator
Bitcoin dollar-cost averaging calculator is designed to help cryptocurrency investors invest in bitcoin, such as. It’s ideal for calculating possible dollar-cost averaging returns if you want to invest in bitcoin, such as.
Should you use dollar-cost averaging as an investment strategy?
Dollar-cost averaging is a smart choice if you’re investing small amounts of money. Nonetheless, it’s important to weigh the advantages and disadvantages of dollar-cost averaging before you proceed.
Do you need more assistance with getting started? I recommend taking free courses on investing for beginners. As you create an investment plan, you can select whether DCA investing fits in the picture.
The bottom line
Dollar-cost averaging could be a useful strategy for investors. With the opportunity to reduce your risk and raise your returns, dollar-cost averaging can be a win-win for most investors. Above all, you must be willing to invest in a long-term investment strategy before committing to DCA investing.
