Investing Basics: Dollar-Cost Averaging
No matter what type of investor you are: using dollar-cost averaging or a constant dollar plan can be a good strategy to lower investment costs, minimize risk, and potentially boost your returns. It involves investing the same amount of money in a target security at regular intervals over a certain period, regardless of price.
Dollar-cost averaging is an investing strategy in which the buyer divides up the amount of money they want to invest and buys in small quantities over time at regular intervals. Investing this way makes it so that market timing has less of an impact on the total price paid. In this case, an investor does not have to attempt to “time the market” to buy at the best prices.
This method makes it easier to deal with volatile market conditions and supports the mindset of investing regularly. Investors may also find decreased average costs per share and a reduced impact of volatility on their portfolios. Another important benefit reported is that it prevents your emotions from undermining your portfolio. There is less stress about making a poor investment or scrambling to buy more at an attractive time.
A simple application of this strategy is with 401(k)s, as employees choose a contribution amount that is sent automatically every set period based on their plan. Dollar-cost averaging can also be used in other tax-advantaged accounts or a taxable brokerage account for regular purchases of mutual funds or index funds.
This method is used by investors of all kinds to build savings and accumulate wealth over time. It can be great for beginning investors looking to trade ETFs who do not have the experience to judge market opportunities. Furthermore, long-term investors lacking time or propensity to time the markets benefit from this strategy.
Be aware, that this strategy assumes that the market will fluctuate with eventual rises in prices. That means it is not useful for investing periods when prices are trending steadily in either direction. Broader market conditions and an investor’s desired outlook need to be considered as well. Another consideration is that repeated investing may result in higher transaction costs.
At this point, you may be wondering how often to invest. As you may have guessed, it depends on your investment time horizon and your outlook on the market regarding volatility. If you believe the markets will rise, it might be a good time to try it out. Consider contributing a certain amount from every other paycheck for investment purchases, working your way up to contributing from every paycheck.