💡Key Insight
- Dollar-cost averaging in investing is a strategy where you invest a fixed dollar amount at regular intervals regardless of the market price, which can reduce the impact of market volatility by buying more shares when prices are low and fewer when prices are high.
- This consistent investment approach helps investors avoid trying to time the market and promotes disciplined, long-term investing habits that can smooth out the average cost per share over time.
- A potential drawback of dollar-cost averaging is that it may result in missed gains in a steadily rising market and can incur higher transaction costs from frequent purchases.
- Dollar-cost averaging is particularly useful for new or risk-averse investors because it removes emotional decision-making from investing and fosters regular contribution routines.
If you’re just getting into investing, there are a number of strategies that people utilise to minimise risk. Dollar cost averaging is one strategy. This is especially relevant to the current financial climate as markets may experience significant volatility due to risky factors like COVID-19.
What is it?
Dollar cost averaging describes the practice of consistently contributing a similar amount of money to one investment during a specific period of time. It is quite popular because, colloquially put, most people don’t want to put all their eggs into one basket. By doing so, you reduce the risk of significant loss but also limit your potential gains.
To learn more about other investing strategies, follow these links on value investing, collectible investing and micro-investing.
How can I do it?
There is no one specific way to dollar cost average. In fact, it might surprise you to know that all Australians already engage in dollar cost averaging through their superannuation accounts. Employers contribute a fixed proportion of our salary to superannuation, like how an investor would contribute a fixed amount to their chosen investment.
One approach is to invest a small amount each period (e.g. $200), whether that be weekly or monthly, for a select period of time for example half a year. This means that over time, you have averaged out investment of your total assets over an extended period of time. Ideally, it should be a long term strategy; time in the market is conducive to success, not necessarily timing in the market.
Advantages
1. Logic
To dollar cost average is to pursue a logical and composed approach to investing. Doing so ensures your decisions are smart and not driven by fear or impulses.
2. Less effort
Instead of studying the market to determine the perfect timing for when to buy and sell shares, dollar cost averaging takes the timing-guesswork out of investing.
3. Less affected by unlucky timing
If you do not dollar cost average, you could end up placing all your money into one investment that performs poorly, and lose your money all at once. Instead, by dollar cost averaging, you can essentially protect yourself from the risk of that arising.
Disadvantages
1. Additional Costs
By making regular trades as opposed to lump sum investments, you will likely be subject to additional costs.
2. Missed Gains
If you have scheduled investments on specific recurring dates with dollar cost averaging, you may miss out on returns. For example, you lose out on potential gains if you for example only invest $200 into one stock every Friday and the stock price dips. You miss out on the opportunity to buy more shares and earn when the stock price eventually rises in future.
3. No Guarantee for Success
While dollar cost averaging is a popular, useful strategy, it by no means guarantees that any investor will gain money. You should also make sure that you have performed substantial research to identify good investment options. This “passive” approach also means that you are not responsive to the inevitably changing nature of the stock market; efforts towards an active strategy may prove more successful at boosting the value of your investments.
Key Takeaways
So what is dollar cost averaging? It is the technique of investing consistent amounts of money towards an investment. Main benefits include the pursuit of a logical strategy, and less risk of loss from unlucky timing. The disadvantages include potential additional costs, missed gains from only investing at predetermined intervals, and no guarantee of success. Overall, if you are a newbie to investing, dollar cost averaging is one simple way to go!
If you would like legal advice before proceeding with any investment strategies, this article explains five questions to take into consideration. Feel free to visit our Lawyer Marketplace to speak to the perfect lawyer to help guide you.
