What Is Dollar Cost Averaging? A Rock Solid Stress-Free Contribution Strategy for Buy-And-Hold Investors!
Buy low. Sell high. That’s the investor’s strategy to take home the most significant return on investment. But we don’t have a crystal ball that tells us when the bottom hits. So we’ll never know precisely when we need to sell shares.
One of the biggest mistakes investors make is trying to time the market. Unfortunately, it can’t be done—more people than not miss out on big gains by holding cash instead of investing regularly.
Sure, you’ll win some, but you’ll lose more.
So it’s time to change the game with dollar cost averaging. Keep reading to learn more about dollar-cost averaging as the best investment strategy for buy-and-hold investors.
What Is Dollar-Cost Averaging?
Dollar-cost averaging (DCA) is an investment technique that entails investing a fixed amount of money regularly over extended periods in the same fund or stock. The investor doesn’t consider the asset’s price at the time of purchase.
This strategy focuses on minimizing the impact of volatility on a stock’s price. As a result, over time, the investment price averages.
Investors invest with a regular, time-repeated plan. As a result, they avoid the fear of missing out and buying high.
Understand How Dollar-Cost Averaging Works
Dollar-cost averaging is not a buy-and-forget strategy. You still need to buy wonderful, strong companies. You have to do your research and identify companies that are worth investing in.
Remember it’s about time in the market, not timing the market.
The power of dollar-cost averaging comes from market rebounds when stocks go lower than when you originally started investing. It averages the lowest lows and the highest highs. Long-term investing produces stable outcomes that you can depend on over time. So, set your goals, make a plan, and follow-through. It’s that simple.
Investing an equal amount over time ensures that your investment purchase price is an average price of all of your purchases rather than a single price. Sure you’ll never buy at the all-time low, but you’ll also never buy at the all-time high.
Why Dollar-Cost Averaging
Unless you’re buying tens of thousands of shares you won’t notice a $10 price change in an asset’s price from one month to the next. Likewise, when you’re only buying one or two, you probably won’t notice a significant difference in a $50 price change.
Since you won’t be able to time the market and these small market fluctuations matter less when you’re buying fewer shares, your plan should include dollar-cost averaging.
Dollar-cost averages keep you disciplined to invest at regular intervals consistently. In addition, it ensures you’re practicing good investing habits.
You’ll remove the emotions behind investing with consistency and confidence. And you’ll learn to ignore short day-to-day changes in stock prices and stay focused on your long-term goals.
Dollar-Cost Averaging Example
Let’s say we have Mary who started a Roth IRA. She sets aside $100 a month to invest in a NASDAQ index fund (Ticker symbol: QQQ).
|Month||Share Price||Contribution||Shares bought||Shares owned||Adjusted Price||Total value|
Please note. The numbers in the example are for illustrative purposes only. They don’t represent real-world data.
The average purchase price is lower in December because she bought shares in the other months. If you had kept the money in a savings account, you would have missed out on the compound interest from January through November.
Of course, if you had taken $1200 and bought all of your shares upfront in January, you would have been able to buy 48 shares. So you would be ahead of the game. But could you have predicted that the low was in?
There were probably 11 more lows and highs before that price hit in January. The extreme opposite could have happened. You could have $1200 at the end of the year to invest, where shares would have cost $45 each. Then you would have only been able to buy 26.7 shares. That’s a loss of more than $325 from waiting.
Imagine what that $325 could do over the next 25-30 years. By October, November, and December, you are buying shares at a significantly reduced price overall because it is averaging with the previous lower purchase prices. This is the key to dollar-cost averaging.
In general, investors who use this investment strategy will cut their purchases over time, leading to greater returns on their investments.
How to Start Dollar Cost Averaging
- First, you need a budget. You need to know how much money you have, how much you need to live, and how much you have left to save/invest. On average, it’s recommended that you save at least 10% of your before taxes earnings every month. However, if you have debt and other responsibilities, you may need to adjust this. Check out this post to learn more about how to make a budget.
- You need an account. First, determine if you need a Roth IRA vs 401 (k). You want to invest in an employee-sponsored plan when possible. If you have a 401K/403B, the amount of money you regularly invest in the stock market is set according to your pay schedule. While you can change this contribution, it’s less time-sensitive.
If you can’t open a work retirement account, look into opening an individual brokerage account/individual retirement account (IRA) and begin investing in individual stocks or index funds. Many personal accounts will let you “automatically pay yourself first” through direct deposits from your checking account. Set up an amount that fits your budget and regularly transfers that money to your brokerage account. Just don’t forget to buy the stocks you intend to. Some accounts put the money in a money market account rather than an investment.
- Begin good money habits. There’s no better time to start working on your financial well-being than now. You have your regular contributions set up, now let’s make a plan to keep them going. You can maximize your budget by:
- Paying off debt
- Canceling unused subscriptions
- Using sinking funds for big purchases
- Fund your emergency fund
- Checking in with your budget at least once a week
- Practicing delayed gratification
- Start a side hustle to be able to invest more
I’m excited that you’re investing regularly. Dollar-cost averaging is a strategy based on consistency regardless of the price. Sure, there will be times when you pay more and times when you pay less for a particular stock. However, it averages over time. Dollar-cost averaging ensures that you maximize your returns by not timing the market.
Generational wealth is built by the motto invest early and invest often. There’s no better strategy than dollar-cost averaging and paying yourself first to answer this call. DCA helps you invest more over time while paying yourself first ensures that you won’t miss an investment. And it teaches you to pay yourself first automatically. As a result, you’ll reach your goals sooner with regularly scheduled contributions.
Theresa is a personal finance blogger. She writes content for busy professional women to take control of their money and investments. She enjoys reading, traveling, cooking, and writing. Her work has been featured on GoBanking Rates, Your Money Geek, Savoteur, the Corporate Quitter, Thirty Eight Investing, and more.