Dollar Cost Averaging (DCA)

If you want to invest in the market and search for a less risky way, you should go for the dollar cost averaging investment strategy. This method is best to avoid huge losses. It also gives you a chance to gain higher profits. But before investing, let’s discuss what it is? How does it work? And what you need to do to implement this plan?

Dollar Cost Averaging: What it Is?

It is a method that provides you a way to manage risk when you are purchasing investments like mutual funds and stocks. Instead of investing all your money at once and at one price, you need to divide the amount you want to invest in Dollar Cost Averaging or DCA. Then, you need to buy small quantities of that particular asset over time at regular intervals. This way, you can save yourself from the risk of dropping prices all of a sudden.

For instance, if you want to purchase $12,000 Apple stock, you can simply invest $2000 on the first trading day of the month. And then do that for the next six months, instead of investing all your money in a lump sum. Or you can invest $2,000 every Friday until you reach the required amount.

This way, DCA helps you to build your stock position in a volatile market. You can also use this method to gather stock positions over the years. In this case, you can invest $5,000 in stock on the first trading day of every year. So, the basic plan of this strategy remains the same, but you can change the way of implementing it according to your goals.

How Does Dollar Cost Averaging Work?

The primary reason why people lean towards this method is that it takes emotional feelings out of investing by setting your purchase in small quantities at intervals. This means you will invest more when prices are low and buy fewer shares when prices get high. For instance, you have a goal to get a $1,200 asset this year; it gives you two choices. You can purchase stocks in a lump sum at the end or beginning of the year, or you can invest $100 every month.

You might think investing through a lump sum or DCA doesn’t have a lot of difference. However, when you divide your purchase into $100 for 12 months, you may get more shares than you could purchase all at once.

DCA Helps Investors with Less Money

If you understand DCA properly, you will know that it helps you invest in small amounts of money from the beginning. Suppose you have a good amount of fortune to invest all at once. DCA will encourage you to invest smaller amounts of that money in the market on a regular basis. This way, a person who doesn’t have a large amount of money to invest all at once can also invest smaller amounts at regular intervals. Thus, they will not have to wait until they have saved a good amount of fortune.

DCA also offers you to invest in the market when the market is on the decline. For some people, this strategy is kind of bizarre to invest when the market is crashing. However, if you withdraw from this market, you will miss out on the chance to buy stocks in future growth. We have learned from history that those who remain in the market during bear markets get better results than those who stop investing.

Do You Have 401(K)?

You might not know, but if you have a working 401(K) or other tax-advantaged retirement accounts, and you are investing in these accounts every month by deducting your payroll, you are doing this through the DCA method.

Suppose your income is $60,000 each year, and you use around 5% of your incomes in 401(K). Moreover, your employers also contribute to this account according to the method of dollar-for-dollar. After calculation, your account will get $6,000 yearly. Additionally, this amount is not a lump sum. Most of it gets deposited into your account every time you get your salary. So, if you get your salary weekly, this means you are depositing $231 in your funds every week.

If you put it another way, you are buying stocks with the DCA method by applying your 401(K) method to your stock investment.

Benefits of Using Dollar Cost Averaging

Helps Avoid Bad Timing

Investing your money all at once while trying to pick the best price to make a stock position and enter into the market is called market timing. This is challenging for most people, even professionals. Many people try to enter the market at the right time. Some of them get success by chance. But others have to face great loss. This is because no one knows when the lows and highs will occur. Not to mention, no one can stop the unwanted situation that can happen.

For this reason, DCA is a disciplined strategy as it saves you from getting exposed to loss in the market. It also rewards you when the stocks recover. DCA helps you deal with market ups and downs by not making decisions according to the timing.

Reduces Risk

DCA is the best strategy to save your money for a longer time. When the market changes between ups and downs, DCA reduces your risk of exposure over time. It also reduces the risk of trying to choose the right time to buy stocks.
When you buy in the falling market, you greatly increase your long term return chances when you purchase stocks after recovering.

Lowers Emotional Investing

This is a common problem for many investors. They make decisions according to their loss experiences, loss aversion, and emotions. For your better understanding, you can say that loss aversion is a behavior of an investor to focus on the ways to avoid losses to acquire only gains.

Researches show that concerns about losses have a powerful impact on your psychology than gains. This forces a person to make mistakes like switching to cash in a down market or needlessly selling holdings. By making the right decision and avoiding media fears or hype about the right time, you can avoid any traps in the market.

Deals with Volatile Market

As we have already discussed, DCA is the best way to buy in uncertain and volatile markets. This method helps you deal with these types of markets without losing a big amount. When you invest in the market without worrying about the fact of high and low, you will eventually get a good result.

Any One Can Invest

If there was only a choice to invest a lump sum in the market, most people could not make their stock positions. In other words, if the strategy encourages you to invest 20,000 in a specific asset, many people could have refused to take part in this method. Of course, there are some benefits of investing all your money at once. But most of the time, you are prone to the risk. Not to mention, if you have a way to invest through the DCA method, then why even trying to get into risk?

Who Should Invest through Dollar Cost Averaging?

You should consider investing through the dollar cost averaging method if:

• You don’t want to dig into the market and do extensive research that is necessary to find out the right time.
• You are a beginner in the market.
• You are focusing on investing small amounts of money.
• You are making regular investments every month in your retirement accounts, such as 401(K) or IRA.

You may want to invest through other strategies if:

• You have a great amount of money to invest through a lump sum.
• You want to try investing at the right time.
• You don’t want to avoid investing your time in extra research.
• You only want to invest for a short period.

How to Initiate Investing through DCA?

You just need to think with an open mind, and you can invest through the dollar cost averaging method like you are investing in your 401(K). Not to mention, you are already following this strategy if you have enrolled in 401(K) at your workplace. It is not hard to make a plan with brokerages. However, you also need to think about which stock or well-diversified exchange trading fund you want to invest in. Once you come up with the answer, you can ask your brokerage to fix a plan from which you can buy automatically at intervals. Additionally, if your brokerage doesn’t offer this type of plan, you can simply set up your plan on a fixed day, such as the first trading day of every month.

You can leave the market if you want to, at any time. But the point is that you have to keep investing regularly, whether the stock prices go high or down or you get any market anxiety. Don’t forget that the bear market is an opportunity for you if you are following the DCA strategy.

Let’s discuss another trick to implement DCA. Usually, funds and stocks pay dividends. You can ask your brokerage to use or reinvest these dividends for the upcoming day of investment. This offers you an interesting way to continue your buy by measuring your gains over time.

Things You Need to Understand

While you have learned all the basic and essential factors and methods to implement and understand the DCA, you need to learn a few things before investing in it. Here are the things you need to understand before making any decision.

• DCA is the most suitable method for people who have a long-term investment horizon and lower risk tolerance.
• This investing method works well when an investor plans to invest for a longer time with volatile investments, such as EFTs, stocks, and mutual funds.
• DCA is not applicable to the money market and bond funds.
• This strategy does not guarantee you a good return on investments. But it is the best method compared to others.
• Using the DCA method to invest every month when the market is continuously falling each month is not a great idea.

These are little things you need to keep in mind while entering the market. Like any other method, DCA has its own benefits and disadvantages. However, its pros are more than any other investment strategies. It is also applicable and gives you higher chances of returns. If you play wisely, there is no chance that you can go into a loss when using DCA.

How to Set Up Your Plan?

To invest in the market through the DCA method, you need three major things.

• First, decide how much money you want to invest. You also need to think about an amount that can continuously remain in the market, and you don’t need it over time. If you want that money after a year or take some part of it, the plan will not be effective.
• Choose any investment or a couple of investments that you want to hold for a longer time. By a longer time, we mean at least five to ten years.
• Pick the time of intervals. It can be weekly, monthly, after every two months, and quarterly. After that, invest your money in your chosen investment. Make sure to ask your broker to set up the automatic investment from your dividends. So the process becomes easier. If your broker doesn’t offer this plan, you can invest without the broker.

Bottom Line

As you have learned, dollar cost investing is a way to invest in the market, preventing you from facing a huge loss. It is also best for beginners or people who have less money to invest. The primary reason investors choose this method to invest in different stocks is that it is easy, simple, and effective. At the same time, other methods require extensive research and, of course, the contribution of your luck so that you don’t get caught in losses that you can’t recover. However, you need to understand that these methods encourage you to invest for longer periods.

Engage with the entire King Financial Network team on www.kingfn.com to see what other expert advice we can provide towards your financial well-being.

Tony Kelly is the Director of Financial Planning and Partner at King Financial Network. Tony focuses on investment planning and economic research. He is responsible for the due diligence of investment companies and portfolios as well as the preparations of KFN’s valued client reviews and performance reporting.

King Financial Network is an integrated, team-based network that takes a comprehensive, customized, and independent approach to guide you through Financial, Retirement, Tax, Insurance, and Estate Planning.

Securities and advisory services offered through Commonwealth Financial Network, Member FINRA/SIPC, a Registered Investment Adviser.

Sources

• https://www.nerdwallet.com/article/investing/dollar-cost-averaging-2
• https://bit.ly/3alYELL
• https://raizinvest.com.au/blog/the-advantages-of-dollar-cost-averaging/
• https://www.nasdaq.com/articles/why-dollar-cost-averaging-smart-investment-strategy-2014-05-19
• https://www.forbes.com/advisor/investing/dollar-cost-averaging/
• https://www.thebalance.com/dollar-cost-averaging-356331
• https://www.fool.com/investing/dollar-cost-averaging-what-investors-need-to-know.aspx