What is Dollar Cost Averaging?
Dollar cost averaging is a method of investing that the common sense investor can employ for buffering against some of the unknown factors involved with stock investing while taking advantage of natural stock market volatility. It also encourages systematic investing, which is an essential factor in the acquisition of wealth.
The ideal goal for stock investing is to buy low and sell high. But stock market highs and lows are unpredictable. Dollar cost averaging provides a systematic way to naturally buy more stock when the price is low and less stock when the price is high, and it saves you from having to “time the market.” Similarly, it protects you from short-term, irrational market movement and benefits from the fact that the markets have a much more consistent track record over long periods of time.
Simply put, dollar cost averaging is a technique used to reduce an investor’s market risk by means of the systematic purchase of securities at predetermined intervals and set amounts. Actually, DCA is a method that is used by many investors without them even realizing it.
With Dollar Cost Averaging, an investor works into a good investing position, not by investing assets in a lump sum, but by slowly buying small amounts over a longer duration of time. By doing this, the investor gets to spread out the cost of investment over several years thus giving a form of insulation against major fluctuations and changes in the market price.
Dollar Cost Averaging, or DCA, is an effective investing technique and requires very little work. The markets, despite having bad days or even years, still have a tendency to go up (or appreciate) over time. By investing a predetermined amount of your money every month you get to buy fewer shares when the market is high and more shares when the market is bearish. As an example, with DCA your investment may buy you five shares in a sluggish market and 10 shares in strong market. This lessens the risk of having to invest a large amount in a single investment during the wrong time. In a falling market the average cost per share is much smaller. This, in effect, will help you gain better overall profits as the market rises over time.
There are people who may say that instead of DCA, it would be better to buy a lot when the market is at its lowest and then sell when it is at its highest. Ideally, of course, this is a good tactic, but then an investor must be able to predict when the market is at its lowest and at its highest to be able to profit from this tactic, which is extremely hard if not impossible. If anyone could do it, he or she would be rich.
For those who are interested in making a dollar cost averaging plan, three things must be considered first:
* You have to decide exactly the amount of money you want to invest every month. You have to make certain that you are financially capable of keeping the amount consistent. Failure to do so may make your dollar cost averaging plan ineffective.
* >You should select an investment that you would want to hold on to for the long term – preferably you should hold on to your investments for five to ten years, or even longer.
* At regular time intervals – it could be weekly, monthly, quarterly or a schedule that works best for you – invest the money in an equity that you have picked out. If your broker offers it, try to setup an automatic withdrawal plan so that the process becomes automated.
As always, when you dollar cost average, do so wisely. Choose good investments (good companies at reasonable/cheap prices) and do not invest blindly.