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When is the best time to invest? Easy answer, when prices are low. Most of us probably already knew the answer to this question. While it is effortless to say it, trying to wait for the optimal moment to purchase or sell an investment is incredibly difficult.
Fortunately, a tried-and-tested approach can assist you in buying more when prices are low and less when prices are high. It’s known as dollar cost averaging.
Hey guys, and welcome back to our channel. In this post, we are going to talk about dollar cost averaging, one of the easiest ways to build wealth.
- So, without further ado, let’s dive right into the post.
What Is Dollar Cost Averaging
What Exactly Is Dollar Cost Averaging? Have you been thinking of purchasing stocks, ETFs, or mutual funds? If so, dollar cost averaging can be an excellent method for managing price risk.
Instead of investing in a single asset at a single purchase price, dollar cost averaging divides the amount of money you want to invest and buys small amounts over time at regular intervals.
In this way, you can save yourself from paying too much before market prices fall. In the stock market, prices do not only shift in one direction.
So, dividing your purchase and making many purchases increases your chances of paying a lower average price over time. Furthermore, dollar cost averaging allows you to put your money to work continuously, which is critical for long-term investment success.
DCA vs Market Timing
Dollar Cost Averaging vs. Market Timing Dollar cost averaging works because asset values tend to grow over time. However, asset values do not grow consistently in the short run.
Instead, their values rise and decrease in short-term highs and lows rather than in a constant pattern. Many people try to buy assets when their price seems to be low.
In principle, this seems simple enough. In reality, even skilled stock traders find it difficult to predict how the market will move in the near term.
- Next week’s low might be a relatively high price. And this week’s peak may seem to be a relatively modest price a month from now.
Only in hindsight can you determine what advantageous pricing would have been for any particular asset—and by then, it’s too late to acquire. When you wait for an asset to reach a desirable price, you may be buying at an inflated price as the asset has already made significant gains.
And attempting to time the market can be pretty costly. According to a Charles Schwab study, investors who tried to time the market had much lower returns than those who invested consistently using dollar cost averaging.
What is the Process of DCA?
Your emotions. Dollar cost averaging removes emotion from investing by requiring you to buy the same quantity of an item on a regular basis.
This ensures that you always buy more when the price is low and less when the price is high. Now assume that you want to put $1,200 into a Mutual Fund this year.
You have two options: invest all of your money at once at the start or end of the year or invest $100 each month. While the difference between the two may not look big, in reality, it is enormous.
If you stretch out your purchases in $100 monthly increments over 12 months, you may wind up having more shares than if you purchased everything at once.
Let us show you a scenario to explain this better. Let’s suppose a share price was $10 in January, but the share had an annual average price of $9.58.
You would possess 120 shares of Mutual Fund A if you paid $1,200 for it in January at the price of $10 a share. But if you invested $100 in the Mutual Fund every month, you would possess 125.24 shares.
- In this case, dollar cost averaging allowed you to purchase more shares than if you had bought them all at once.
DCA Help Those With Less Investment?
Does Dollar Cost Averaging Help Those with Less investment? One of the reasons we love dollar cost averaging is because, in practice, it allows you to start investing with much less money.
You may not have substantial cash to invest all at once, but dollar cost averaging will enable you to invest smaller sums of your money on a regular basis and build the habit of investing.
You won’t have to wait until you have a more significant sum saved to profit from market growth this way. Regular dollar cost averaging investments also guarantee that you invest even when the market is down.
Maintaining assets amid market downturns might be scary for some individuals. In low markets, however, you risk losing out on future gains if you stop investing or takeout your current assets.
Many market studies support this. According to Charles Schwab research, people who stay invested during down markets have traditionally outperformed those who withdraw their money and then attempt to time a market rebound.
- Is Dollar Cost Averaging Effective?
Is DCA Effective?
Dollar cost averaging does not always work smoothly outside of hypothetical instances. In fact, according to studies from the Financial Planning Association and Vanguard, dollar cost averaging may underperform lump sum investments over the long run.
This is because a lump sum investment would simply be in the market longer. If you have a substantial amount of money to invest, it is recommended that you invest it as soon as you find the right opportunity.
However, don’t let this study derail you. You may not have much money saved up, and delaying may lead you to lose out on advantages you can gain from dollar cost averaging.
Also, it may be difficult for you to invest massive amounts of money all at once, remember our emotions and risk tolerance can work against us.
Instead, it may be psychologically more manageable for you to invest little amounts of money over time. Furthermore, dollar cost averaging continues to help your money grow.
According to the Financial Planning Association and Vanguard data, investors who adopted dollar cost averaging saw considerable investment growth—just slightly less than if they had invested a single amount most of the time.
Now, keep in mind, lump sum investment outperforms dollar cost averaging. If we look at statistics more closely, two out of three times lump sum investments beat dollar cost averaging.
The thing to notice here is that 1/3 of the time, dollar cost averaging yielded better results! So, while lump sum investing may produce better results in the long run, dollar cost averaging still allows you to start investing immediately with as little money as you can spare instead of waiting until you have a lump sum.
As with all elements of investing, it’s vital to examine possible rewards as well as your risk tolerance. Investing your whole savings account at once may offer more significant returns than modest amounts over time.
However, suppose you want to decrease your risk and regulate your emotions or you worry about turbulent market circumstances? In that case, dollar-cost averaging may be a reasonable strategy—even if it means missing out on some possible benefit.
