When it comes to investing, there are a lot of different opinions about what’s the best way to do it. However, one strategy that many professional investors seem to agree on is Dollar Cost Averaging (DCA). In fact, it’s the simplest form of investment that has been used since the 1900s and continues to be used by some of the top investors today. Some critics, however, say that it’s not worth the hassle and can lead to losses in some cases. So, which is it? Is dollar cost averaging (DCA) a good idea?
Before I dive into it and share my thoughts, let’s form a quick basic understanding first…
The idea behind Dollar cost averaging
Dollar cost averaging (DCA) is an investment strategy in which an investor divides the total amount invested across periodic purchases of a target asset. These purchases occur regardless of price and at regular intervals.
The point behind dollar cost averaging is that it distributes risk over time, protecting investors from market fluctuations by spreading out their purchases.
Does It Really Work?
The answer is YES!
According to Rebecka Zavaleta, creator of the investing community First Milli, “Dollar-cost averaging has demonstrated that it actually performs better during a period of high market crashes. And the frequency of market crashes is more than ever, especially with the election coming up.”
You see, the main benefit of dollar cost averaging is that it removes the need to time the market, which can be incredibly difficult by investing a fixed sum of money into security or asset at fixed intervals.
You’re essentially buying regardless of the asset’s price. This protects you from the adverse effects of volatility and leaves you less stress when making investment decisions.
How to implement DCA strategy in practice?
Let’s say you wanted to invest $100 per month in Apple stock in 2021.
On month 1: Apple stock is trading at $10 per share, so with $100, you can purchase 10 shares.
On month 2: Apple stock is trading at $5 per share, and with your monthly investment of $100, you can purchase 20 shares.
On month 3: Apple stock is trading at $4 per share, and with your monthly investment of $100, you can purchase 25 shares.
By the end of the 3 months, you had invested $300 and owned an average of 55 shares of Apple stock.
If you continue through the year 2021 at $10 per share, you’ll end up with a total purchase price for your nine months’ worth of investments of $900 ($100 × 9 months) and 90 shares purchased at that cost price.
The total for 12 months: 145 shares of Apple stock for $1200.
The magic behind DCA
This makes sense for many investors because it can help you avoid the risk of buying all your shares at the wrong time — when prices are at their highest point.
Let’s say you have $1,200 to invest in one stock. If the current market price is $10 per share and you purchase all 120 shares at once, there’s always a chance that the stock will drop in value after you make your purchase. You’ll have to hope that it eventually goes back up so that you can break even or make a profit.
In this scenario, you’ll still wind up with 120 shares in your portfolio, but when averaged out over 12 months, you will have purchased those shares at a lower average cost per share than what you would have initially paid for them.
However, with dollar cost averaging: You will be able to own 145 shares of Apple stock compared to 120 shares of Apple stock in one lump sum!
Ultimately, dollar cost averaging is one of the best strategies that I use to help me ride out the ups and downs of the market while keeping my stress levels low. However, don’t think of it as a magic bullet to eliminate risk; instead, consider it another method that can add some safe diversification to your overall portfolio.
In many ways, it’s helped me feel more confident with my investments and better understand the market as a whole. If anything, this strategy indeed isn’t going to hurt your wallet or portfolio.
Click here to learn more about stock diversification.
I hope that sharing my experience will make it easier for you to decide if this investment strategy is right for you.
Watch the following video that inspired me to write this post on dollar cost averaging.
Disclaimer: I’m not a financial advisor and cannot legally provide financial advice. I have done this study purely out of personal interest in the financial world. Any risk you take in investing money should be taken as just that, a risk. Please do your own research and consult with qualified professional points of view before investing your hard-earned money.