Investments are risky. But dollar-cost averaging can help minimise that risk. With this basic strategy, investing in stocks gets safer – and simpler – and bumps up the probability of higher returns. Dollar-cost averaging offers a second option when trying to invest. So, you either invest the total of your funds or split it into equal sums in regular installments.
A prime everyday use of dollar-cost averaging is 401(k). An amount earmarked from your salary is used to purchase the predetermined investment option of choice. The same model can work for other investments outside 401(k) plans.
If you’re a beginner, dollar-cost averaging is a technique you’ll need to master because you probably still have a low appetite for risk. On that note, here are the three core things to know about the investment method.
Market Realities Make Dollar-cost Averaging Necessary
Everyone wants an ideal situation where they buy a stock low and sell high. But most of the time it doesn’t happen that way. Timing the market is not as easy as it sounds. One wrong move, one delayed minute, and you’re running at a loss already.
Many times, the stock market goes against logic. For instance, general talk on the investment scene may suggest to “buy when the market is moving up”. In that case, what if the stock is about to tank? Also, as you probably know, when the market is down, people become afraid and keep selling. What if the market goes back up? That’s a loss of potential gains already.
Stock markets are not respectors of the people, and lots of emotion can be involved. That’s why cost-dollar averaging is a necessity. It takes the emotion out of investing, helping you fall into a safe routine, irrespective of what the market is saying. Doing this gives you the best of any market condition because you’re not ‘all in’ at any time.
So, even when the market behaves terribly, your losses are limited.
How Dollar-Cost Averaging Works
With this method, you purchase the exact amount of an asset regularly. Because you’re splitting your funds, the purchases each time are small. So, when the share prices are high, your purchase is low. When the share prices are up, you get more.
A practical example is you budgeting $2,400 for investment this year. There are two roads you can follow. You can either put forward the lump sum all at once in January or use $200 every month over 12 months. This way, you are hedging your risks.
At the end of one year, you may accrue more shares than when you invest all at once. You should notice the word ‘may’ in the previous sentence. It is because the situation doesn’t always come off perfect. A report proves that sometimes dollar-cost averaging performs less well than investing lump sums.So, if you win a bonus at work, you shouldn’t discard the idea of investing all at once.
Dollar-Cost Averaging is Kinder on People with a low sum
While this report above holds water, if your investment budget is low, it’s safer – psychologically and financially – to invest in installments. You don’t want to lose all your money at once if there’s a sudden drop in share value.
Practically, dollar-cost averaging makes it easier for low-money investors to get into the scene. So, if your news channel makes you feel that only large sums can guarantee return on investment, they are wrong. You don’t have to save long-term before you invest.
You can get into a consistent investment cycle when you don’t get swayed by market conditions. So, even when it’s a bear market, your investment goes in, and you stand a chance to benefit from future growth – which almost always happens.
Also, if you don’t have much time to research the market in-depth every time, dollar-cost averaging is a safe system to imbibe. You won’t have to worry about timing to get the TSLA. You also won’t need to worry about what Elon Musk is saying on Twitter that could affect the share price.
Dollar-cost investment is all about simplicity. It even works better than buying the dip – because you won’t need to chase a dip; your money is already there when it happens. So, here is your cue to get started.
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